Page 135 - Profile's Unit Trusts & Collective Investments - March 2025

Understanding Asset Allocation

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

Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts 133