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Hedge funds regain momentum in Q3; Inflows double to USD16.9bn

According to Chicago-based Hedge Fund Research Inc. (HFR), a nearly 1% Q3 sector-wide performance gain has largely reversed the 1% loss in Q2.

HFR's latest Q3 research confirms that the hedge fund sector posted a 0.9% performance gain for the third quarter 2004, almost reversing a 1.0% loss in the second quarter of this year.

Based on the HFRI Fund Weighted Composite Index, which measures equally-weighted performance across 19 distinct fund sectors, the industry also saw USD 16.9 billion in net asset inflows in the quarter, a marked improvement over the USD 7.5 billion in inflows seen in the second quarter.

The increase suggests a return to the faster rate of capital flow experienced in the 12-month period ending March 30, 2004, when net inflows averaged USD 21.2 billion per quarter.

As a result of stronger inflows and performance gains, total hedge fund assets under management rose to USD 889.8 billion, up 2.7% from the USD 865.9 billion tallied at the end of Q2. Year-to-date, hedge funds have returned an overall 3.57% and have seen USD 46.6 billion of inflows.

Joshua Rosenberg, President of HFR, said: "Underlying global market conditions were characterized once again by choppy and trendless trading patterns, making it difficult for many sector categories to find opportunities."

He added: "However, with the swing to positive gains in third quarter, a majority of funds demonstrated an ability to deal with these less than favorable conditions. It is interesting to note that in our nearly twelve years of tracking hedge fund performance, only once, in mid-1998, have we seen two consecutive down quarters."

Top Category Stories for Q3 2004:
One overriding sector trend that emerges from the Q3 data is the rising popularity of multi-strategy funds such as the USD 116.7 billion Event Driven category (inflows of USD 3.1 billion in Q3) and the USD 110.2 billion Relative Value Arbitrage category (USD 2.2 billion in Q3 inflows).

These funds, which are designed to offer a heightened level of diversification to single fund investors, have recently enjoyed significant inflows. HFR data shows that year-to-date, Event Driven and Relative Value categories have returned 5.4% and 3.4%, respectively.

A close examination of the data available in the Q3 HFR report reveals a number of other interesting sector trends (all performance figures are based upon the HFRI Monthly Performance Indices):

* The USD 26 billion Emerging Markets sector, which invests in foreign securities or the sovereign debt of developing countries, saw a sharp 5.2% performance return in Q3 reversing a 5.0% drop in Q2. HFR attributes the turn-around to the resiliency of the Chinese economy, which quickly shrugged off the pessimism that had predominated in Q2. Other factors include the solid growth and stability in Latin American economies, particularly Brazil. Year-to-date the category has returned 9.65%.

* The USD 41.7 billion Distressed Securities category notched another strong performance with a 1.9% return in Q3. Year-to-date, the category is up 10.3%, leading all other non-sector categories. HFR attributes these results to the continued tightening of credit spreads and the successful restructuring of companies emerging from bankruptcy.

* The USD 264 billion Equity Hedge sector, which remains by far the largest single-strategy fund category, stemmed its 1.2% negative performance in Q2 with flat performance in Q3. The category has returned 2.2% year to date.

* The USD 102.3 billion Macro category, which makes leveraged bets on anticipated price movements of stock markets, interest rates, foreign exchange and physical commodities, returned 0.3% in Q3 versus a loss of 3.3% in Q2. Despite the swing into positive territory, the sector has returned only 0.6% year to date.

* Strategy-specific arbitrage fund categories (USD 44.6 billion Convertible Arbitrage and the USD 14.2 billion Merger Arbitrage) languished with performance slightly down to flat in both categories during the quarter. Convertible Arbitrage continued to suffer from unfavorable market conditions and still low levels of volatility limiting investment opportunities while the slow pace of corporate transactions continue to hamper Merger Arbitrage funds. Fund flows slowed considerably in Convertible Arbitrage and Merger Arbitrage posted a USD 342 million outflow of funds in Q3 (2.4% of total assets in the category).

* Not surprisingly given the rise in crude prices, the USD 4.1 billion Energy Sector category experienced a robust quarter, returning 8.8 % to investors. Year-to-date, the category has returned 21.4%, leading all hedge fund categories.

* The USD 24.2 billion Technology Sector category experienced significant turbulence in the quarter, posting a negative 4.8% return while seeing asset outflows of more than USD 1 billion.

Background Note: The HFR Industry Report for Third Quarter 2004 contains more than 120 pages of charts and graphs provided in both PowerPoint and Adobe Acrobat formats. For more information on the Report or on HFRI Indices, please visit the HFR links on

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