Private equity investments and hedge funds are lumped together as alternative investments for retirement funds – quite why I am not sure, because they are poles apart, both in their investments and in their approach.

Hedge funds are essentially groups of asset managers of varying degrees of skill seeking to make short-term gains from gaps in the market and/or market volatility. To my mind, more akin to gambling than investing.

Private equity funds actually invest in something – namely, companies producing something or providing an actual service. This can range from investing in a company such as the private equity-owned retirement fund service provider Alexander Forbes, to a chain of hotels, or even a chicken farm.

So a private equity fund, using money of investors, such as retirement funds, will buy a controlling interest in a listed company such as financial services company Alexander Forbes, delist them, hopefully turn them around financially, and either resell them or relist them, hopefully at a profit for the investors.

Private equity managers also seek out companies that need start-up capital or expansion capital. In doing so, many private equity managers also provide the companies in which they invest with skills to ensure they survive.

Private equity does have other risks, such as appropriate valuations, particularly at the start of the investment, and the lack of liquidity (meaning it would be difficult to sell the investment before maturity).

Private equity has the potential to build economies – hedge funds do not, they are mainly gambles looking for short-term profit.

In South Africa, at least, there is also a fallacy perpetrated by the hedge fund industry that an investment in hedge funds is low- risk – a claim that is nonsense.

Private equity funds never stop emphasising that their offerings are risky – namely the risk that the companies in which they invest will fail.

In contrast, the hedge fund industry too often tries to camouflage the risks for investors.

Take, for example, a recent statement by Robert Foster, convenor of the Association for Savings & Investment SA (Asisa) Hedge Funds Standing Committee:

“Hedge funds should not be seen as a higher-risk alternative to, say, unit trust funds. They should be seen as one of the building blocks of a well-diversified investment portfolio. Simply put, most hedge funds aim to reduce market volatility for investors in a portfolio.

“In 2008, for example, when the global credit crisis caused immense stock market volatility, the FTSE/JSE All Share Index (Alsi) returned minus 23.23 percent for the 12 months to the end of December 2008. Portfolios in the SA multi asset medium equity collective investment schemes category returned minus 9.98 percent for this period. South Africa’s top 10 hedge funds by size, however, delivered an average return of minus 0.06 percent, effectively preserving capital. The aggregate of all hedge fund strategies achieved a positive 9.03 percent for the same period.

“And while hedge funds are generally referred to as expensive, the statistics show that 65 percent of all local hedge funds charge annual management fees of one percent, while only 9.4 percent charge two percent. However, not all hedge funds charge annual management fees.

“Hedge fund managers that charge performance fees generally earn between 10 and 20 percent of a fund’s out-performance above a mandated benchmark.

“A key consideration for investors in hedge funds is the liquidity of underlying assets. The 2013 statistics show that 90 percent of assets under management by the hedge fund industry in South Africa can be liquidated within 10 days, which is well within the average investor notice period of 30 days,” Foster says.

Nearly every one of Foster’s statements is misleading. For example:

* Comparing the universe of hedge funds with unit trust funds is simply dishonest. It is like comparing a pear to an elephant, so misleading it is. Risk in both categories varies tremendously. The low risks of a money market fund can never be beaten by anything in a hedge fund stable.

* Any claims about performance in the hedge fund industry are questionable because of the rate of fund shutdowns, which create a bias in the performance figures. Badly performing funds shut up shop far more than in the unit trust industry. And Foster admits that records on shutdowns are not kept.

* On costs, he avoids the question of the multi-layering of costs when money is invested in funds of funds, as most of it is. These layered costs are not shown in the survey used.

* On liquidity, Foster does not find it useful in his statement to compare the 30- to 60-day hedge fund notice of withdrawal to the 48 hours of unit trust funds. He did so, however, in a media briefing, which I did not attend.

Let’s be absolutely clear: hedge funds are in the high-risk category and it is time the industry stopped trying pretend otherwise.

To mislead retirement fund trustees with this type of nonsense is simply inexcusable.

Hedge funds are mainly about long- and short-term positions in the financial market. Retirement funds are about long-term returns. If there is a specific short-term risk to a retirement fund, such as an employer undertaking significant retrenchments, then the fund can hedge (insure against) the risks of market volatility – it does not need to invest in hedge funds to do so.

Over the long term, much of the volatility of markets is removed, so that is not an argument either.

Foster now says that he did not set out to mislead anyone. Well, he needs to be a lot more judicious in his statements. The money we are talking about is that of ordinary workers, many of whom simply cannot afford losses because of high risks or higher costs.