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Hedge funds advance in December as equities decline, says Hennessee

The Hennessee Hedge Fund Index calculated by hedge fund adviser Hennessee Group gained 0.30 per cent in December, even as equity markets posted their first negative fourth quarter in a decade.

'December was again a solid month for hedge funds, as most funds were able to hold their own in another difficult equity environment,' says managing principal E. Lee Hennessee. 'Most strategies posted gains in December, and all 23 of the Hennessee Hedge Fund Sub-Indices outperformed the S&P 500 for the year.'

The Hennessee Long/Short Equity Index advanced 0.25 per cent in December and gained 12.08 per cent for the full year. The financial and consumer sectors continued to be the weakest sectors across the equity markets, while energy and technology were again standout performers. As throughout the year, there was a high differentiation among industry and stock returns, with five sectors positive and five negative, creating a good environment for bottom-up stock pickers.

'The market continues to price in a higher likelihood of a recession for 2008 and is calling for more rate cuts,' says Hennessee co-managing principal Charles Gradante. 'Unfortunately, the Fed is in a bind as inflation continues to inch higher as evidenced by last month's inflation report indicating CPI grew 0.8 per cent in November, the largest increase in more than two years. We believe inflation is somewhat out of the Fed's control and being largely affected by demand for commodities from BRIC countries.'

The Hennessee Arbitrage/Event Driven Index advanced 0.10 per cent in December and 7.78 over the year as volatility in the equity and fixed income markets affected arbitrage strategies. Despite widening credit spreads, the Hennessee Distressed Index posted a gain of 0.95 per cent for the month and was up 8.87 per cent for 2007 as a whole.

For the year, high-yield credit spreads widened from 2.9 per cent to 5.8 per cent over the 10-year Treasury although defaults remain at 26-year lows. Widening credit spreads also posed problems for convertible arbitrage funds, with the Hennessee Convertible Arbitrage Index declined falling 0.40 per cent in December, although it was up 4.36 per cent over 12 months.

Implied volatility remained at elevated levels, with the VIX ending the year at 22.5. The Hennessee Merger Arbitrage Index declined by 0.17 per cent in December as a few deals broke and spreads widened as a result of the volatility in equities, but gained 11.58 per cent over the full year.

'Macro managers made substantial gains with a three-legged trade in 2007: short the dollar, long gold and long oil,' Gradante says. 'The declining dollar and rising oil prices led to a 30 per cent increase in the price of gold. In 2008, gold may receive demand for other reasons. Gold is the third currency for central bank reserves, which are too concentrated in dollars and euros and therefore want to diversify into gold.'

The Hennessee Global/Macro Index advanced 0.56 per cent in December for a cumulative 15.59 per cent in 2007. While equities generally declined globally, long/short international funds were able to hold their own, with the Hennessee International Index advancing 0.79 per cent for the month and 20.02 per cent for the full year.

Macro funds also performed well, with the Hennessee Macro Index gaining 2.08 per cent and finishing the year up 15.13 per cent. Strong gains were generated in commodities, especially oil, which approached USD100 per barrel, and gold, which exceeded USD800 per troy ounce. The dollar reversed course to rally against both the euro and yen, while Treasury prices were generally flat, even though the Fed lowered rates by 25 basis points in December.

The Hennessee Hedge Fund Indices are calculated from performance data reported to the Hennessee Group by a diversified group of more than 1,000 hedge funds. The Hennessee Hedge Fund Index is an equally-weighted average of the funds in the indices, derived from the group's database of more than 3,500 hedge funds and net of fees and unaudited.

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