Hedge funds struggled to cope with extreme volatility in March and short bias was the only strategy in positive territory for the month as the Hennessee Hedge Fund Index declined by 2.02 p
Hedge funds struggled to cope with extreme volatility in March and short bias was the only strategy in positive territory for the month as the Hennessee Hedge Fund Index declined by 2.02 per cent, according to Hennessee Group, an adviser to hedge fund investors.
‘March proved very difficult for many hedge funds as extreme levels of volatility have been difficult to manage,’ says managing principal E. Lee Hennessee. ‘The collapse of Bear Stearns caused many funds to reduce equity exposure, which was followed by a rally in equities on news of a bailout.’
The Hennessee Long/Short Equity Index declined by 2.03 per cent in March and by 4.33 per cent in what was the worst quarter for the strategy since the WorldCom default in the third quarter of 2002.
While losses are expected from long/short equity funds in declining equity markets, Hennessee says, losses were larger than typical in the first quarter as many funds were unable to generate alpha in long and short portfolios.
‘We are seeing a number of hedge funds invest in levered loans that banks have priced in the mid-80s in an attempt finally to sell some of the ‘hung bridge’ loans of the past leveraged buyout boom,’ says the firm’s other managing principal, Charles Gradante. ‘This should provide a floor for the high-yield debt markets unless defaults pick up beyond current expectations of 4 per cent, which would likely require a very deep recession.’
The Hennessee Arbitrage/Event Driven Index declined by 1.39 per cent in March and by 2.46 per cent for the quarter, while the Hennessee Distressed Index was down 1.12 per cent and 3.14 per cent respectively.
High-yield credit spreads widened to a peak of 8.5 per cent over Treasuries at mid-month before tightening at month-end, Hennessee Group notes. Many managers have reported purchasing levered loans as they have become more attractively priced in recent months.
While most managers believe that corporate defaults will increase over the next 12 months, creating opportunities in distressed debt, the amount of defaulted debt remains currently limited, causing many managers to hold high levels of cash.
The Hennessee Merger Arbitrage Index fell by 0.49 per cent last month and was down 1.93 per cent for the quarter, as spreads widened as a result of volatility in the equity markets and the termination of several private equity-sponsored buyouts due to financing issues.
The Hennessee Convertible Arbitrage Index fell by 2.12 per cent in March, pushing performance for the first three months of 2008 into a 1.74 per cent decline. While volatility spiked at mid-month, with the VIX reaching a high of 37 on the day of the Bear Stearns bailout, it subsequently fell, and weakness in the credit markets made for a difficult environment for convertibles.
‘Due to the collapse of the fixed-income markets, macro managers are finding opportunities in municipal bonds, auction rate preferred securities, and mortgages,’ Gradante says. ‘All of these asset classes are trading at spreads to Treasuries that haven’t been seen in decades.’
The Hennessee Global Macro Index fell 2.74 per cent in March and by 3.48 per cent so far in 2008 as international equity markets lagged those in the US and the MSCI EAFE Index fell by 1.52 per cent.
Performance for international long/short equity funds also trailed that of US long/short equity funds, with the Hennessee International Index declining by 3.26 per cent, accounting for most of the 3.91 per cent quarterly decline. The Hennessee Macro Index dropped 2.16 per cent in March but was the only strategy outside short biased to post positive returns for the quarter with a year-to-date return of 2.28 per cent.
The commodity boom, which had escaped the global risk aversion over the previous nine months, was finally interrupted in March as the Reuters-CRB Index plummeted 8.7 per cent, led by agricultural commodities. The dollar resumed its decline as the euro appreciated from USD1.51 to USD1.58.
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 net of fees and unaudited average of the funds in the indices, derived from the group’s database of more than 3,500 hedge funds.
