Blue Chip Issue 90

INVESTMENT | Hedge funds
BLUE
CHIP
of 25% on your R800 000 just to get back to where
you started. If you had lost 50%, you would need a
gain of 100% just to get back to your starting point.
Another feature of compounding is that large
single-loss events can severely disrupt a longterm
process of compounding. Consider an
investment that returned 25% annually for 10
years and then lost 90% in the 11th year. That
investor would be down on his initial capital,
despite 10 straight years of fantastic returns
and one terrible year.
The nature of compounding means that
despite the arithmetic average of the annual
returns over the 11 years being 14.5%, this
is irrelevant to the poor investor who has lost
initial capital and whose compound annual return
is negative. You cannot eat arithmetic returns.
Investors live in a world where losses are also
compounded through time and a solid record
of annual average returns can be undone by a
single large loss.
The avoidance of losses, especially large losses, is
paramount to overall investment outcomes through time.
It is therefore unsurprising that the positive impact on a
portfolio which simply avoided the 10 worst months on the JSE
over the last 14 years is more than 50% greater than the impact
of missing out on the 10 best months. It is far more important to
avoid the losses than it is to take full advantage of market rallies.
Consider an investor who invested R1-million into the JSE ALSI
on 1 May 2009 (the launch date of the Steyn Capital QI Hedge
Fund). By 30 September 2023, this ALSI portfolio would have been
worth R5.3-million. However, if this investor was a savant with
perfect knowledge of the future and who simply skipped the 10
worst months on the JSE over the next 14 years, his portfolio as at
30 September 2023 would have been worth almost double the
ALSI portfolio, at just over R10.3-million. Said differently, sitting
out just 6% of the months over the 14-year investment period
adds the equivalent of five times the investor’s starting capital
to his result.
This is the power of compounding. Conversely, had the investor
instead been so unfortunate as to miss out on the 10 best months,
his investment would be worth just over R2-milliom, a pedestrian
result to be sure, but in rand terms far less impactful than the gain
of avoiding the worst months.
The chart shows the portfolio outcomes for a range of scenarios
our savant may have chosen.
One of the significant advantages of hedge funds is their
ability to harness this phenomenon by mitigating downside risk
while still participating in market upside. Indeed, one of the key
characteristics of the Steyn Capital hedge fund strategy is our
strong focus on downside protection, which since inception has
significantly reduced both the frequency and depth of portfolio
drawdowns, allowing the magic of compounding to do its thing.
In fact, in the 10 biggest monthly drawdowns on the JSE since the
inception of our strategy, our strategy has generated a positive
median return, with the median return of our strategy across all
the JSE down months being positive 0.8% compared to the JSE
ALSI median return of -2.4%. The cost of this downside protection
is that in months of blistering market rallies, we’re unlikely to
keep up. But for long-term investors, who understand the power
of compounding and who rightly focus on the ultimate portfolio
outcome, the long-term results speak for themselves.
James Corkin, Portfolio Manager, Steyn Capital Management
www.bluechipdigital.co.za
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