36ONE Asset Management is an independent owner-managed specialist investment manager based in Johannesburg, South Africa. Our investment philosophy is to focus on fundamental analysis while using a macro overlay to understand which themes complement our fundamental approach and for risk management purposes with the aim of generating above-average real returns. We continually manage our investments in a flexible manner to reflect changing market conditions.
36ONE Hedge fund is a long/short equity hedge fund with a focus on the South African equity market. Please give us a brief introduction of your fund and the background of the funds key personnel.
The 36ONE Hedge Fund is a long-biased fund which aims to generate absolute returns throughout the cycle through superior stock selection. This is 36ONE’s flagship rand fund and has generated a net return of 19.6% p.a. since inception 10 years ago. Due to client demand we have created a more conservative version of the strategy, called the 36ONE Fund. Both the 36ONE Hedge Fund and the 36ONE Fund are available in US dollar denominated, currency hedged mirrors for international clients.
The fund has been managed since inception by Cy Jacobs, with the support of a small but experienced team of analysts. Cy co-founded 36ONE in 2004, prior to which he managed a various funds for Investec and HSBC in Johannesburg.
What are the key features of 36ONE Hedge Fund’s approach to investing? How do you distinguish your fund among your peers investing with a similar strategic mandate and geographic exposure?
We follow the same investment approach across all our funds and focus primarily on bottom-up, fundamental research, with macroeconomic views playing a supporting role in portfolio construction. We differ from peers with similar strategies in a number of ways. Firstly, our net equity exposure is maintained in a fairly narrow range; in other words we do not attempt to time the market. Secondly, we aim to avoid large bets and instead maintain a portfolio that is well diversified at all times; this has enabled all our hedge funds to achieve volatility figures in the mid-to-high single digit range since inception. Finally, we have a style agnostic approach to stock picking, whereas value is the dominant style among South African fund managers. We are flexible and trade around our fundamental long and short positions regularly.
The 36ONE Hedge Fund was incepted in 2006. Over the last 10 years, how has your portfolio allocation within the South African market evolved? What are some of the other key markets which you allocate to within the region?
Since inception the fund has consistently invested the majority of its assets in the South African equity market. Sector allocations vary over time and we have no sector bias. During the early years the fund had no size bias, but over time the focus shifted towards mid and large caps in order to maintain a high level of liquidity at all times. Another structural shift was a gradual increase in exposure to international stocks in order to enhance diversification. The exposure to markets outside South Africa is capped at 25%, with the current allocation around 15%.
Looking back at the fund’s history, 36ONE Hedge Fund had a good year in 2007 with returns of 35.57%, the highest on record till today. Please share with us some of the key factors which contributed to your success during this year
2007 was a strong year for the South African stock market, which gained 19.2% on the back of strong economic growth, driven largely by the mining industry. The fund capitalised on this theme by investing in a number of miners but more so in industrial companies that serviced the mining industry. The fund also profited from investments in the construction and materials industry, which performed well on account of an urbanisation driven construction boom. The fund managed to avoid large losses in the financial sector, which performed poorly during the tail end of a sharp rate hiking cycle.
In 2011, the fund returned 19.17% with all 12 months of positive returns, while hedge funds globally languished with losses of 1.77% over the same period. Tell us a little bit more about some of your most profitable trades which lead to this outperformance.
The South African stock market was marginally positive in 2011 as the recovery from the 2009 financial crisis was picking up speed while investors remained sceptical. The fund’s performance was driven by consistent stock picking which generated positive returns in both the long and the short book. This time around the basic materials sector played a smaller role than in 2007, with consumer goods, financials and industrials making the largest positive contributions.
The 36ONE hedge fund significantly outperformed global hedge funds for two consecutive years in 2014 and 2015. Could you shed some light on this against the backdrop of your propriety investment methodology?
The South African market gained 16.6% in rand but lost 20.8% in US dollar over the two year period while the 36ONE Hedge Fund delivered 37.1% in the rand class and 20.5% in the US dollar class.
Over the two years there were large divergences in market performance at sector level: the consumer services sector gained 9.0% in US dollar terms while the basic materials sector lost more than half its value. The fund’s bias towards globally diversified, high quality enterprises and away from commodity based businesses served our investors well. Furthermore, the currency hedging policy of the US dollar mirror funds ensured that our non-South African investors did not have their returns diluted by adverse currency moves.
What are some of the strategies you employ in order to enhance your returns and manage your risks? Given the inherent risks of investing in emerging and frontier economy markets, how do you manage your downside risk especially during periods of high market volatility?
The Johannesburg Stock Exchange was rated the second best regulated exchange in the world in 2015 by the World Economic Forum. South African reporting standards are also world leading, which means the quality of financial reporting is higher than in most developed markets. As a result, many of the typical emerging market risks related to corporate governance and transparency are largely absent in the South African market.
Meaningful risks that remain include reduced liquidity and elevated volatility when global sentiment turns against emerging markets. In order to mitigate these, we constantly monitor liquidity levels in our funds to ensure that we are able to meet large redemptions during times of stress without prejudicing the remaining investors. Volatility is managed by always having short exposure to the South African equity market, via put options or futures, and also hedged exposure to the South African rand, which acts as a proxy for global risk.
For a fund domiciled in South Africa, how have the newly implemented regulations governing hedge funds in South Africa affected the operating costs of the 36ONE Hedge Fund?
We support the recent introduction of regulations that allow for the creation of retail hedge funds in South Africa. The industry regulator has received a large number of applications for funds to register under the new regime and is currently working through the backlog so it may be some time before implementation is complete and hedge funds become a meaningful part of the retail investment landscape.
The regulatory burden of the new regime is negligible for 36ONE and likely to be minimal for the local hedge fund industry as a whole. Although hedge funds themselves were unregulated in the past, hedge fund managers have been regulated by the Financial Services Board since 2002. This means the additional regulatory burden rests not with the hedge fund managers themselves, but with the specialist fund administration companies that will administer the new retail hedge fund vehicles.
Given the depreciation in emerging currencies against the US dollar over the last few years, emerging market funds have struggled to provide a similar level of returns to both domestic and overseas investors. Do you feel this could be a challenge for your fund as well in attracting investments from non-domestic entities/individuals?
South Africa’s currency, the rand, has historically been volatile, even by emerging market standards. As such, currency is one of the key risks we monitor in our portfolios. The structure of the South African equity market allows us to express a positive or a negative view on the rand through stock selection; in recent years, our funds have been indirectly short the rand and thus benefited from its depreciation. Furthermore, our dollar based funds are mandated to hedge out all direct long rand exposure. This policy has contributed to stable hard currency returns for our international investors, who now make up more than half of 36ONE’s hedge fund assets.
Lastly, what is your outlook for the global economy in 2016, in particular for South Africa? How well prepared is your fund for future opportunities?
We expect the key macroeconomic themes that have dominated the news this year to continue driving markets for the remainder of 2016. Due to heightened levels of uncertainty, particularly around monetary policy, market reactions to even marginal changes in economic indicators are becoming increasingly severe. Against this backdrop, diversification is key and we therefore avoid large exposures to individual risk factors. We continue to monitor domestic and international markets and will increase our risk appetite when appropriate. We believe that the bifurcation of monetary policy between the major central banks could lead to further divergences at country, industry and company level which will continue to provide investment opportunities for flexible stock pickers such as ourselves.