Why hedge funds should be core to pension fund portfolios
By Kwazi Mbhele | Portfolio Manager, Novare Investments
For many pension fund trustees, hedge funds remain on the sidelines – often misunderstood, frequently overlooked, and rarely given the airtime they deserve.
Yet their consistent performance through years of market turbulence, their ability to manage downside risk, and their power to smooth returns over time make them a natural fit for retirement portfolios.
If there was ever a time to reconsider hedge funds, it’s now.
The last few years have served up no shortage of volatility. From surging inflation and rapid interest rate hikes to renewed geopolitical instability – not least the ongoing war in Ukraine and rising tensions around Taiwan – markets have had much to digest.
Add to that an unpredictable US election cycle in 2024 and uncertainty around fiscal and monetary policy, and investors have been navigating an environment defined by risk.
For pension funds, which require both capital preservation and steady, inflation-beating returns, this landscape can be especially challenging.
Trustees are tasked with meeting liabilities, preserving members’ savings, and ensuring long-term sustainability – all while avoiding major drawdowns that could erode value at the worst possible time.
It’s a tall order. This is where hedge funds can help.
Hedge funds have a reputation problem.
To many, the name still conjures images of high-flying traders, complex strategies, and excessive fees. But the reality, especially in South Africa, is quite different.
Local hedge funds are regulated under the same collective investment scheme framework as unit trusts, ensuring transparency, daily pricing, and strict disclosure.
Many strategies are designed specifically for risk-averse institutional investors. They aim not to shoot the lights out but to manage volatility and protect capital.
That’s why it’s surprising how underused they still are. Regulation 28 allows retirement funds to allocate up to 10% to hedge funds, but actual allocations remain far below this limit.
According to our 2023 Novare Annual Hedge Fund Survey, total industry assets stand at just R106.8 billion – a fraction of the R3.87 trillion that’s floating around just in the collective investment schemes (CIS) industry.
This underexposure suggests that many funds are missing an opportunity to diversify meaningfully and improve their risk-return profiles.
Globally, this is beginning to shift. A recent Barclays survey of investors managing over $8 trillion showed that pension and insurance funds are expected to increase their hedge fund allocations from 9% to 19% in 2025.
Endowments and sovereign wealth funds are also lifting their exposure. The reason? Hedge funds have consistently demonstrated their ability to navigate complexity and deliver positive returns, even when traditional assets struggle.
In South Africa, the hedge fund industry delivered its best performance ever last year, according to data compiled by HedgeNews Africa.
HedgeNews Africa’s Fund of Funds Composite Index, for example, returned 15.9% in 2024 after fees, outperforming both the FTSE/JSE All Bond Index (13.6%) and the FTSE/JSE All Share Index (13.4%).
And it wasn’t a one-off. At Novare, we’ve seen our Mayibentsha range of funds of hedge funds outperform equities and bonds through nearly every major market shock since 2008, including the global financial crisis, Nenegate, Covid-19, and the post-pandemic inflation cycle.
In Hard Times: Novare’s funds have outperformed during severe market turbulence.
What makes hedge funds so effective in these conditions? It’s the flexibility to use tools that traditional managers often can’t – including the ability to take short positions, use derivatives prudently, and apply risk overlays to preserve capital.
When markets fall, hedge fund managers don’t just sit on the sidelines; they can adjust and take advantage by taking short positions. That ability is invaluable in periods of decline in markets.
Our three Mayibentsha funds are designed with different risk-return profiles in mind, all aligned with inflation-linked objectives.
The Market Neutral Fund targets CPI +2.5% with a low-to-medium risk profile; the Moderate Fund aims for CPI +3.5%; and the Focused Fund, which has a higher risk profile, targets CPI +4.5%.
Each is a fund of hedge funds, drawing on Novare’s two decades of experience in selecting and monitoring managers across various strategies, sectors, and asset classes.
The name Mayibentsha – meaning “let it be new” in isiXhosa – speaks to our pioneering role in bringing hedge fund solutions to South African institutional investors.
But the principles behind these funds are firmly grounded in long-term thinking: manage risk, protect capital, and steadily compound returns over time.
And crucially, the performance has come with less volatility than traditional asset classes. That makes a difference for pension funds needing to make monthly payments to members.
Drawdowns in volatile equity markets can force funds to sell assets at a loss. Hedge funds, with their smoother return profiles, can reduce this risk, creating more predictable outcomes for trustees and members alike.
Fees are often raised as a concern, but here, too, much of the apprehension is outdated. Performance fees or incentive fees as they are called, are only charged after a fund beats its benchmark – and all fees are disclosed upfront.
In evaluating hedge funds, trustees should look not just at costs in isolation but at risk-adjusted returns. The real question isn’t, “Are they more expensive?” It’s, “Are they delivering value relative to their cost?”
In short, hedge funds are not just for the adventurous or the wealthy. In South Africa, they’ve evolved into transparent, regulated, institutionally focused tools for managing investment risk.
Yet many trustees still default to conventional portfolios that are heavily exposed to equities and bonds – both of which can underperform in periods of stress. Diversification isn’t just a buzzword; it’s a safeguard.
Of course, hedge funds aren’t a cure-all. However, if used well, they can form a core component of a retirement fund’s strategy.
The key is to be clear on what you want the allocation to achieve: smoother returns, downside protection, or long-term outperformance. Then, partner with asset consultants or multi-managers to find the right solutions.
In an environment where uncertainty has become the norm, hedge funds are no longer a luxury. They are a necessity – and it’s time trustees made better use of them.
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