NEDGROUP HEDGE FUND REVIEW SEPTEMBER 2006 This Review1 has been published since December 2003. For previous reviews, please visit www.nedgroupinvestments.co.za or, for further information 2 , contact Mohini Naidoo at email@example.com A rapidly weakening rand caused a nervousness among local interest rate sensitive shares, rousing further volatility in the equity market. During early September the FTSE/JSE All Share Index lost nearly 8%, but promptly recovered again to deliver 2.3% for the month. The BESA All Bond Index gained 1.4% during September. The funds participating in the Nedgroup Hedge Fund Review gained, on average, 1.1% after fees during September, but the level of performance varied significantly across the different hedge fund categories. The best performing hedge fund category for the month was the trading category, delivering 2.0% on average. Within this category the Badger Quant Strategy Fund delivered the highest return for the month: 5.6%. The funds in the long/short equity, fixed interest and market neutral categories on average achieved returns of 1.3%, 0.6% and 0.0% respectively. End of September coincides with the publication of the quarterly Nedgroup SA Hedge Fund Index figures. The Index delivered 12.0% for the year-to-date, against the FTSE/JSE All Share Index’s 26.3%. The BESA All Bond Index lost 0.1% during the first nine months of 2006. Since inception (1 January 2001) the Nedgroup SA Hedge Fund Index delivered an annualised return of 22.5% p.a. at a volatility of 6.8%. Over the same period the FTSE/JSE All Share Index generated returns of 23.0% p.a. at a volatility of 19.2%. The Nedgroup SA Hedge Fund Index displayed very little correlation with the FTSE/JSE All Share Index at +0.06. The BESA All Bond Index return and the STeFI Interbank Call Rate for this period are 13.4% p.a. and 9.1% p.a. respectively, at annualised volatility levels of 6.8% and 0.7%. At the end of the previous quarter we warned that the local hedge funds’ outperformance of equities defies the investment adage of higher risk delivering higher returns over the long run, as equities display much higher volatility than hedge funds. Well, for the first time since the publication of this Index equities have outperformed the South African hedge fund industry over the total period for which we hold monthly returns. However, the nominal performance of South African hedge funds over this period is still unusually high when you view it in light of the volatility associated with the equity and hedge fund indices respectively. We expect the volatility of the Nedgroup SA Hedge Fund Index to remain bond-like, but anticipate that the extent of the out-performance of the equity market over hedge funds will increase with time. What kind of returns and volatility can one expect from each of the four categories? Trading funds typically perform well when the market picks up momentum (either during a bull or a bear market). Within a sideways moving market or a market that whiplashes frequently, they can and often have negative returns over 12-month periods. The volatility of this group is normally as high as, if not higher than, that of the equity market. Some of these funds aim to outperform the FTSE/JSE Top 40 Index. That is not possible while at the same time protecting capital over short periods of time, as risk and return are inseparable. The majority of long/short equity funds have target returns of between cash plus 3% and cash plus 8% p.a. and their volatility is typically between half and two-thirds of that of the equity market. Market neutral funds normally target returns of between cash plus 3% and cash plus 6% p.a. at low volatilities. The fixed interest funds are typically the most conservative hedge funds in South Africa, with very low volatility and accompanying cash plus 2-3% returns. Rolling 12-month returns 90 70 50 30 10 Nedgroup SA Hedge Fund Index -10 FTSE/JSE All Share Index BESA All Bond Index STeFI Interbank Call Rate -30 Dec-01 Mar-02 Jun-02 Dec-02 Mar-03 Jun-03 Dec-03 Mar-04 Jun-04 Dec-04 Mar-05 Jun-05 Dec-05 Mar-06 Jun-06 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 What should also remain unchanged is the superior capital protection of hedge funds over periods as short as one year. While the greatest 12-month loss experienced by investors in the FTSE/JSE All Share Index over the past six years is 29.2%, the South African hedge funds participating in this Index, as a group, have never returned less than 14.5% over any 12-month period during the past six years, while returning as much as 39.3% during their best performing year. 1.There is no warranty of any kind, expressed or implied, regarding the information or 2.This publication provides factual historical information about the performance of any aspect of this service. Nedgroup Investments shall not be responsible for and the listed funds only, as received by the respective asset management houses and disclaims liability for any loss, damage (whether direct or consequential) or expense of relied upon by Nedgroup Investments. It is not an invitation to invest in any of these any nature whatsoever, which may be suffered as a result of, or attributable to, the use fund or reliance upon the information provided in this Review. NEDGROUP HEDGE FUND REVIEW September 2006 Maximum Open for Fund 1 Month Standard Inception total gross new size in Return to 1 Year Return to 2 Year Return deviation over Sharpe Sortino Asset management house Fund name date exposure money? R'm 30/09/2006 YTD Return 30/09/2006 Rank to 30/09/2006 Rank last 24 Months Ratio Rank Ratio Rank Fixed Interest opportunities category: Cadiz Malachite Fund Dec-05 1200% Yes 156.0 0.1 3.1 Coronation Granite Fixed Income Fund Oct-02 1000% Yes 259.0 0.8 8.6 12.0 12.4 3.1 1.7 4.2 PSG Absolute Investments South Easter Fixed Interest Fund Nov-05 1200% Yes 63.4 1.1 1.3 Average - Fixed interest opportunities 0.6 4.3 12.0 12.4 3.1 1.7 4.2 Long/short equity category: 36ONE Asset Management 36ONE Hedge Fund Apr-06 200% Yes 240.0 2.4 Armin Diem for Alpha Macro Fund Managers Pty Ltd Absolute Alpha Fund Nov-03 150% Yes 40.4 2.2 23.9 30.3 4 47.5 1 16.8 2.0 5 8.0 5 BlueBay Fund Managers Mayflower Fund Oct-03 350% Yes 806.5 0.8 11.9 20.9 7 28.5 5 10.4 1.9 6 4.1 6 Cadiz Emerald Fund Jul-06 300% Yes 26.0 -0.1 Cadiz Sapphire Fund Nov-02 400% No 463.0 0.5 7.3 9.6 11 12.5 8 6.5 0.8 8 1.6 8 Clear Horizon Capital Multi-Strategy Fund Oct-05 500% No 470.0 0.5 14.4 18.2 8 Coronation Presidio Fund Oct-05 300% Yes 25.2 1.0 7.2 13.9 9 Oryx Oryx LLP Fund Nov-04 300% Yes 495.0 2.8 25.5 34.8 3 Oryx Oryx Segregated Fund May-03 200% No 379.0 2.9 25.7 36.2 2 45.0 2 12.6 2.5 3 13.1 3 Peregrine Capital High Growth Fund Feb-00 500% No 111.9 1.4 22.3 38.3 1 39.6 3 8.7 3.1 2 14.8 2 Peregrine Capital Performance Fund Jul-98 500% No 150.9 0.2 12.6 22.3 6 26.9 6 7.1 2.5 4 8.2 4 Praesidium Praesidium SA Hedge Fund Dec 03 200% Yes 289.3 1.7 19.1 27.1 5 28.7 4 5.5 3.5 1 18.0 1 Taquanta Taquanta Hedge Fund Composite Dec 02 300% Yes 1.5 0.0 11.0 9.7 10 16.1 7 9.5 0.9 7 3.2 7 Average - Long/short equity 1.3 16.5 23.8 30.6 9.6 2.2 8.9 Market neutral category: Allan Gray Optimal Fund Oct-02 200% Yes 860.9 0.7 5.3 7.9 9 7.6 7 1.5 0.5 6 1.0 6 Coronation Domestic Multi-Strategy Arbitrage Fund Jul-03 300% No 308.3 0.7 10.3 14.2 7 14.9 4 3.2 2.4 3 7.9 3 Fairtree Capital Fairtree Market Neutral Fund Oct-03 350% No 387.6 -1.0 10.3 17.5 4 25.0 1 5.3 3.0 1 9.3 2 GP Joubert & Company GPJ Segregated Hedge Fund Jun-03 150% Yes 6.8 2.0 19.6 21.5 2 17.0 3 8.8 1.1 4 2.5 4 Gryphon Alpha Fund Jan-05 300% Yes 34.4 -0.8 7.9 15.5 6 Gryphon Market Neutral Equity Fund Jan-03 200% Yes 65.0 -1.0 6.8 10.2 8 9.5 6 2.6 1.0 5 1.9 5 Huysamer Capital Investments HCi Conservative Hedge Fund Jun-04 160% Yes 19.6 0.2 2.7 2.9 10 5.5 8 2.5 -0.5 8 -0.7 8 Peregrine Capital Pure Hedge Fund Jul-98 400% No 104.3 0.1 9.6 16.0 5 17.8 2 3.5 2.8 2 14.2 1 Stanlib Quasar Fund Oct-02 300% Yes 105.9 2.7 14.6 18.2 3 T-Cap Pardus Hedge Fund Jul-05 300% No 248.0 -0.8 7.6 21.8 1 Worldwide Capital Ploutos Capital Fund May-04 1000% Yes 221.0 -2.3 -6.8 -9.3 11 12.1 5 17.0 0.4 7 0.7 7 Average - Market neutral 0.0 8.0 12.4 13.7 5.5 1.3 4.6 Trading category: DWT Securities Badger Quant Strategy Fund Jan-04 500% Yes 15.8 5.6 35.0 65.5 1 44.4 1 26.4 1.3 2 2.8 3 Future Tactics Garden Hedge Fund Jan-04 200% Yes 1.4 3.8 11.1 24.8 3 20.1 5 9.5 1.3 1 3.5 1 Gryphon Doulos Fund Jan-06 400% Yes 3.1 -0.5 11.7 Interneuron Freestyle Fund Mar-02 100% Yes 170.4 -0.2 5.7 12.0 5 21.3 4 12.8 1.1 3 2.9 2 Rock Capital Management Honey Fund Jul-06 150% Yes 6.4 2.0 Signal Futures Signal Automated Fund Aug-04 200% Yes 5.0 5.3 23.0 38.7 2 T-Cap Isivuno Hedge Fund Feb-05 300% Yes 44.6 0.3 0.5 3.9 7 Top-Flite Top-Flite Eagle Fund Jan-06 500% Yes 54.0 4.1 27.9 Trendline Trendline Diversified Fund Jun-00 350% Yes 72.7 -0.2 9.5 9.3 6 22.0 3 22.4 0.7 5 1.5 5 Trident Capital Trident Absolute Opportunities Fund May-06 250% Yes 100.9 0.5 Vega Centauri Fund Composite Oct-04 300% Yes 10.1 1.1 19.7 17.4 4 23.6 2 21.5 0.8 4 1.6 4 Average - Trading 2.0 16.0 24.5 26.3 18.5 1.0 2.5 Notes: Total: 6823.1 Average: 1.1 12.5 19.4 22.6 9.9 1.6 5.6 The performance figures quoted in this Review are subject to changes as and when the managers submit annual audit certificates. (All returns are published net of fees. Both risk adjusted measures are calculated using the past 24 months' data) Market Indicators: FTSE/JSE All Share Index 2.3 26.3 36.1 41.8 15.3 All Bond Index 1.4 -0.1 5.0 9.2 5.9 STeFI Interbank Call Rate 0.6 5.1 6.8 6.8 0.1 MEET THE MANAGERS Kyle Hulett, Nick Middelman and Arno van Wyngaarden Cadiz Emerald Fund Asset management house: Cadiz Specialised Asset Management (CSAM) focuses on the management of absolute return funds. CSAM currently has one of the largest absolute return teams in South Africa, managing a range of offerings that include protected investments, hedge funds and inflation plus funds. CSAM also manages long-only equity funds, bond funds and money market funds. The Emerald Fund came into existence in July 2006 and the fund’s objective is to seek absolute returns that are not correlated to the market. Fund managers: Kyle Hulett Nick Middelman Arno van Wyngaarden All three managers hold B.Bus.Sci degrees from UCT and are CFA charter holders, with Kyle also holding an FFA (Fellow of the Faculty of Actuaries) designation. Nick and Arno both have 10 years experience in managing long/short equity hedge funds in South Africa. They joined Cadiz in 2002 and have co-managed the Cadiz Sapphire Fund for 4 years. Kyle was previously at SyMMetry where he started and managed their Fund of Hedge Funds. He then moved on to manage a hedge fund at Prescient for a year before joining Cadiz in 2006 to co-manage the Emerald Fund. Which fund strategies do you employ? The wider the mandate of a fund, the more freedom the fund’s managers have to add value. The Emerald Fund has a wide long-short equity mandate allowing the fund to profit from any value opportunity within the market. This includes, amongst others, NAV arbitrage, statistical arbitrage, event strategies and pairs trades. The fund can take directional exposure through outright long and short positions to exploit market-timing opportunities. The overall directional exposure is actively managed according to the team’s market view. This market view is based on global valuations and economic factors impacting the South African market. What investments do you typically use in your portfolio? The fund takes long and short positions in JSE shares and futures. The portfolio is constructed from individual equity stocks researched fundamentally on a bottom up basis. This involves detailed financial analysis of the company and the sector in which it operates, as well as an understanding of the economic environment in which the company operates. This is combined with management meetings that are designed to establish the drive and competency of the company leaders. Stocks are then compared against others in their sector/operating environment using proprietary models. Once the investment decision is made technical trading disciplines are used to time the entries and exits of the various positions. The fund is completely independent from the Cadiz house view; however, the team has access to Cadiz in-house research as well as numerous sell side brokers to supplement the independent research. What differentiates the Cadiz Sapphire and Cadiz Emerald Fund? The Sapphire Fund is one of the longest standing funds in the industry and has successfully traded through bear markets. The Emerald Fund leverages off the expertise of the Sapphire Fund with a slightly more aggressive mandate and smaller fund size. The fund has a very strong fundamental bias with the fund managers continually visiting a substantial number of companies. This provides great insight into what is happening in the companies and aids in the formation of the macro view. What type of returns can an investor in this fund expect and at what volatility? The Emerald Fund targets cash + 12% after fees with a volatility of roughly 10% while the Sapphire Fund competes in the market neutral space. Both funds are expected to perform well in a market driven by fundamentals but with sufficient volatility to give attractive entry and exit points. GLOSSARY Absolute returns Returns unrelated to, and independent Standard The average fluctuation of a of, any index measure of performance. deviation series of returns around its mean. Asset allocation Taking a view on whether domestic Short position The seller sells shares he does equity, bonds or cash, or perhaps not own on the calculated basis offshore asset classes will be more likely that before he must deliver the to experience growth during the stock, he will get the chance to proposed investment term and allocating purchase the shares at a lower the fund's capital accordingly. price. Fixed interest These strategies attempt to capture mis- Systematic trend These strategies take a opportunities pricing within, and across, global fixed following directional view in markets based income markets and associated on computer models. The derivatives. Leverage is used to enhance strategies reflect an emphasis on returns. market trends and behavioral psychology. Global macro These strategies employ a top-down Sharpe ratio This ratio measures the return of geared equity macro-economic approach to a fund, adjusted per unit of opportunistic investing globally. volatility. It is calculated by Managers will attempt to exploit changes deducting the risk free return on in interest rates, exchange rates and cash from the fund return. The liquidity for different instruments. result is then divided by the fund's standard deviation. Long/short equity This is a broad category of strategies Sortino ratio This ratio measures the return of fund characterised by long positions in a fund, adjusted per unit of securities expected to appreciate in downside risk. It is calculated by value, together with short positions in deducting the risk free return securities expected to depreciate in from the fund return. The result value. is then divided by the fund's downside deviation from the risk free rate of return. Market neutral This usually involves being Value investment Value funds invest in shares with equity simultaneously long and short in low relative price:earnings ratios, matched equity portfolios of the same shares trading at a discount to size within a country. These portfolios their net asset values or shares are designed to have no directional bias with dividend yields significantly towards a potential bull run, or a potential higher than the market average. bear market. Maximum total The sum of the absolute value of the gross exposure long and short position exposure to the market.