Abstract
The hedge fund industry in South Africa has undergone positive changes in terms of both regulation and structure since 2007. These changes provide an opportunity to utilise hedge fund strategies and hedge fund managers, who have long been touted as good portfolio diversifiers, to improve both risk and return characteristics of a diverse range of multi-asset and equity-centric portfolios. The opportunity created has brought about the requirement to model the interrelationships between the major hedge fund strategies and the local equity market in order to understand the dynamic linkages that may be present in both the long- and short-term. In so doing, the ability for asset allocators, portfolio managers and advisors to efficiently match their objectives in terms of risk reduction or risk enhancement is improved. The objective of this study is to improve the portfolio management process of investment professionals by providing evidence as to the diversification benefits, risk reduction capabilities and return enhancement potential of various hedge fund strategies in South Africa. Leading from this, inferences are made as to how hedge funds may be used within strategic and tactical asset allocation. The analysis of long-term dynamics indicated that there is no cointegration between the All Share Total Return Index and the hedge fund strategy return indexes as measured in both a pairwise fashion and within a VAR system under Johansen cointegration methodology. Supporting the cointegration findings, pairwise Granger causality tests provided evidence that there are no directional causal impacts between any of the hedge fund return indexes and the equity market. The analysis of short-term dynamics ensued within a reduced form-VAR where impulse responses indicated limited causality between the hedge fund indexes and the equity market, while variance decomposition showed few spill-over effects from the equity market to the hedge fund indexes. The overall findings imply that a South African investor could achieve diversification benefits in both the short- and long- term by adding hedge funds to an equitycentric portfolio. The findings also provide evidence that hedge funds could be used as effective components within tactical and strategic asset allocation.
M.Com. (Finance)