Page 138 - Profile's Unit Trusts and Collective Investments 2021 issue 2

CHAPTER 7

To make warrants on expensive shares more
Hedging affordable, the issuers frequently use a conversion
ratio, which means that (for example) ten warrants
Hedging is a strategy for reducing
risk by taking an opposite position need to be exercised in relation to one share of the
in another market. An importer of underlying equity.
goods, for example, is exposed to fluctuations in Use of Derivatives by Unit Trust Funds
the rand, and may suffer losses if the rand Traditional unit trusts (ie, those that are not
weakens. To protect against this possibility, he
can enter into a forward contract to buy rands, hedge funds) are permitted to use derivatives to a
locking in what he regards as a favourable limited extent. In other words, derivative
exchange rate. The importer is therefore short instruments such as futures and options are not the
rands in the physical market (ie, he doesn’t yet exclusive preserve of hedge funds - they may be used
have the rands he will need to pay for his by ‘ordinary’ unit trusts but to a smaller degree.
imports), and long rands in the forward market Paradoxically, non-hedge funds are essentially
(ie, has a contract to buy rands at a fixed price). restricted to actual hedging. In other words, the
derivative exposure of an ‘ordinary’ unit trust is
limited to its long positions. For example, a fund
Hedge Fund holding R100m in equities plus cash of R100m
A hedge fund is a collective could sell futures to generate a short position worth
investment scheme which tries to up to R100m (which would make the portfolio fully
generate very high returns from hedged), or could buy futures to generate further
trading rapid, short-term market movements. long exposure of up to R100m. A QI hedge fund, on
The term “hedge fund” is often a misnomer, the other hand, could use futures to create exposure
because many hedge funds don’t do much far in excess of assets under management.
hedging! The term arises because these funds Remember that futures (and other derivatives) are
tend to use derivative instruments – the same geared instruments – a margin payment of
instruments used by hedgers – to take (typically) ten to fifteen percent of the market
aggressive, leveraged positions. Some hedge exposure is needed to enter into the contract. Hence
funds (those more deserving of the name!) cash of R10m could buy equities worth R10 million
specialise in arbitrage and program trading, and (ie, rand for rand exposure), or, in the futures
minimise risk through a sophisticated use of market, equity exposure of nearly R100 million (ten
derivatives which allows fund managers to
exploit price anomalies without being exposed to times gearing). In practice, QI funds are restricted
market movements. by regulations to exposure of 300% and retail hedge
funds to 200%.

Alternative Investments
The category of alternative investments, or exotics, includes everything that doesn't fit into the
four traditional asset classes (cash, bonds, property and equities). Because the category is so broad
it is difficult to give a clear definition; exotics can include everything from collectibles like fine art,
wine and vintage cars to intangibles like derivatives and crypto currencies (Bitcoin).
There are many sub-categories that are seen as "exotic" in more traditional investment settings
but not in others. Precious metals and physical commodities, for example, would be exotics for
most retail investors but are stock in trade for many specialist investors and derivatives traders.
Hedge funds are sometimes considered part of alternative investments, sometimes as a distinct
investment category.
Rand-denominated funds in South Africa registered under CISCA are not permitted to invest in
alternative assets like fine art, gold bullion, Persian carpets or livestock. Overseas, however, there
are dozens of funds that offer alternative assets to investors. One ETN (symbol COW) issued by
Barclays Capital provides exposure to cattle and hogs. At least half a dozen ETFs allow investors to
add baskets of cannabis stocks to their portfolios. There's an ETF that provides long exposure to
the dry bulk shipping market through a portfolio of near-dated freight futures contracts on dry
bulk indices.
Many alternative investment funds are unregulated and unlisted (ie, investors deal directly
with the fund manager). Such private funds are often illiquid and have high fee structures.

136 Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts