Page 128 - Profile's Unit Trusts & Collective Investments - March 2026

Chapter 7 Understanding asset allocation

obligation of either selling or buying the asset from the
Hedging option holder if the option is exercised.
Hedging is a strategy for reducing From a hedging point of view, options can be used in
risk by taking an opposite position much the same way as futures. Which type of instrument
in another market. An importer of a fund manager uses will depend on a variety of technical
goods, for example, is exposed to fluctuations in factors, including the cost of options and the type of
the rand, and may suffer losses if the rand weakens. exposure sought.
To protect against this possibility, he can enter into Warrants
a forward contract to buy rands, locking in what he
regards as a favourable exchange rate. The importer A warrant is a particular type of traded option, usually
is therefore short rands in the physical market (ie, created with ordinary shares as the underlying assets.
he doesn’t yet have the rands he will need to pay for On the JSE, warrants are listed in the same way as
his imports), and long rands in the forward market ordinary shares and have the advantage that they can be
(ie, has a contract to buy rands at a fixed price). traded through a stockbroker in the same way as other
JSE securities.
The price quoted for a warrant in the paper is the
Hedge fund “premium” payable for the rights attached to the warrant
(ie, the right to buy or sell an underlying share on or
A hedge fund is a collective investment before a certain date). Like any other option, the warrant
scheme that uses a broad range of has a strike price, for example, R100 per share.
strategies – including derivatives,
short selling, and sometimes leverage – to generate To make warrants on expensive shares more
returns that differ from general market movements. affordable, the issuers frequently use a conversion ratio,
which means that (for example) 10 warrants need to be
Despite the name, many hedge funds do not focus exercised in relation to one share of the underlying equity.
on hedging; instead, they may take directional or
opportunistic positions. Others specialise in arbitrage Use of derivatives by unit trust funds
or market-neutral strategies, using derivatives to Traditional unit trusts (ie, those that are not hedge
minimise risk and exploit pricing anomalies. funds) are permitted to use derivatives to a limited
extent. In other words, derivative instruments such as
futures and options are not the exclusive preserve of hedge funds – they may be used by “ordinary”
unit trusts but to a lesser degree.
Paradoxically, non-hedge funds are essentially 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 could sell futures to generate a short position worth
up to R100m (which would make the portfolio fully hedged), or could buy futures to generate further
long exposure of up to R100m. A qualified investor (QI) hedge fund, on the other hand, could use
futures to create exposure far in excess of assets under management. Remember that futures
(and other derivatives) are geared instruments – a margin payment of (typically) 10% to 15% of
the market exposure is needed to enter into the contract. Hence cash of R10m could buy equities
worth R10m (ie, rand for rand exposure), or, in the futures market, equity exposure of nearly R100m
(10 times gearing). In practice, QI funds are restricted by regulations to exposure of 300% and retail
hedge funds to 200%.
Alternative investments
The category of alternative investments 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; alternatives 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.

126 Profile’s Unit Trusts & Collective Investments March 2026