Why investors need retail hedge funds

The final draft of the alternative investment funds (AIF) regulations is welcome.

Years of underperformance of traditional unit trusts (‘long only’) hampered by unfriendly management fees, perennially poor equity market returns and more recently, the Covid-19 pandemic, the 2020 Russian-Ukraine war (underpinning the rising global inflation) and the election fever make AIF an attractive consideration.

In particular, the introduction of hedge funds is of utmost importance. While this type of AIF has been greatly misunderstood in the past, one perception has always stood out — when the stock market is performing poorly as it is now, talk of using hedge funds tends to increase.

This leads to the big question — if AIFs are essential, the question on everyone’s lips remains, why have retail investors been shunned to participate in them?

The proposed regulations did not have the retail investor in mind. The Sh1 million minimum investment is enough testament — an investor is expected to maintain this minimum in book value throughout their investment in the AIF.

Retail investors should be in the mix. There’s a value proposition for retail investors to invest in hedge funds. Places such as South Africans have realised this and allowed the existence of retail investor hedge funds, which accept as little as low as Sh350,000 for investments.

The simple question is — if Kenya already has an army of retail investors embracing the most speculative corners of the investment world (read crypto), why are hedge funds off-limits? If we have regulated online retail platforms utilising leverage, why should we fear for retail investors already utilising the same strategies?

If it’s considered good investment practice for hedge funds to make up 15 to 21 percent of an investor’s assets, why should retail investors be denied this diversification benefit?.

Retail investors should be allowed to explore alternative investment funds. They too need to enjoy positive returns when the market is underperforming. According to the Hedge News Africa return data, hedge fund managers succeeded in generating positive performance this year (5.94 percent year to date).

To compare, year-to-date losses at the Nairobi Securities Exchange (NSE) stand at 14.8 percent, 12 percent and 14.4 percent for NASI, NSE 20 Share Index and NSE 25 respectively.

Hedge funds should be open to the common man on the street. These vehicles should no longer be exclusively available to high-net-worth individuals. Even if it means adding extra protections such as daily prices. Of course, like all strategies, nothing is fool-proof.

There’s a high survivorship bias with hedge funds compared to their long-only counterparts, fee structures are equally unfriendly to investors plus it’s proven that hedge funds (and other alternative funds) do not always protect against the downside.

That notwithstanding, with the ability to utilise leverage finance and short selling, hedge fund managers are far better tooled than their long-only counterparts to successfully navigate volatile markets and, thereby, help not only protect their investors’ wealth but also grow it. If so, why should retail investors be the only ones left out?

The writer is the Managing Director at Canaan Capital.