Index providers confirm hedge funds' decline in January

US hedge fund investment advisory firm Hennessee Group has reported that the Hennessee Hedge Fund Index it compiles fell by 2.45 per cent in January, while Chicago-based Hedge Fund Research says its HFRI Weighted Composite Index declined 1.80 per cent. Both figures are provisional because many funds have yet to report their January performance to index providers.

'January was a difficult start to the year for most hedge fund strategies,' says Hennessee Group managing principal Lee Hennessee. 'The Hennessee Hedge Fund Index had its fourth worst month in history after August 1998, April 2000 and July 2002,' she added, referring to months affected respectively by Russia's debt default, the bursting of the dot-com bubble and the collapse of high-flying telecoms firm WorldCom.

However, Hennessee points out that the average decline for hedge funds was significantly less than the fall in US stock markets, with the S&P 500 down by 6.12 per cent in January, the Dow Jones Industrial Average by 4.63 per cent and the Nasdaq Composite Index by 9.89 per cent.

HFR says that apart from its short bias index, which gained 6.70 per cent, six other strategy and sector indices were in positive territory for January, led by the HFRI Macro Systematic Diversified Index with 2.64 per cent. Heavy losers included the Equity Hedge Index with 4.14 per cent, energy/basic minerals with 4.19 per cent, technology/healthcare with 4.93 per cent and quantitative directional with 5.75 per cent.

Some of HFR's regional emerging market indices fared even worse, with Asia ex-Japan down 7.60 per cent and Russia/Eastern Europe off 7.16 per cent, while the overall HFRI Emerging Markets Total Index fell 5.97 per cent. The firm's fund of hedge funds composite index was down by 2.57 per cent.

The Hennessee Long/Short Equity Index declined 2.79 per cent in January amid equity market volatility. Winners from 2007 were the stocks that fell furthest in January, causing funds that posted gains last year to post substantial losses for the month, while financial and housing-related sectors that performed weakly in 2007 outperformed in January.

In addition, the firm says, many funds reduced portfolio risk as a result of heavy declines in equity indices at the beginning of the month, and found themselves under-exposed to a strong rally in equity indices at the end of the month.

'Many hedge funds have turned relatively negative on US equities in recent months,' says Charles Gradante, Hennessee Group's other managing principal. 'Most see weakening top-line revenue growth due to economic weakness, while cost pressures are likely to cause margins to tighten from historically high levels as commodity prices cause real problems for most industries. As a result, net exposures at most funds have declined by at least 10 per cent in recent months.'

The Hennessee Arbitrage/Event Driven Index fell 1.04 per cent in January. Credit strategies were again weak, with the Hennessee Distressed Index declining 2.45 per cent. The spread on the Merrill Lynch High Yield Index widened from 5.4 per cent to 5.8 per cent over Treasuries as signs of an increase in the default rate began to emerge and liquidity remained poor. Most expect the high-yield default rate to increase to 4 per cent by the end of this year.

Convertible arbitrage benefited from higher levels of equity implied volatility, as the Hennessee Convertible Arbitrage Index gained 0.58 per cent. Merger arbitrage spreads also widened because of the turmoil in the equity markets and financing difficulties for several leveraged buyouts still creating a backlog. The Hennessee Merger Arbitrage Index declined 0.74 per cent.

'Macro funds are adding to their short position in the 10-year Treasury, while holding onto their long position in the 2-year Treasury, believing that the yield curve is likely to steepen,' Gradante says. 'This reflects the view that stagflation is a real threat. Oil and gold are being shorted as supplies of both have exceeded demand, while manager are long agricultural products, especially sugar.'

The Hennessee Global Macro Index declined 2.92 per cent. International equity funds fared worse than their US counterparts, as European and Asian equity prices fell, with investors doubting that Asia has decoupled from the US economy. The Hennessee International Index declined 3.24 per cent for the month. However, macro funds performed well, with the Hennessee Macro Index gaining 1.35 per cent.

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