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Hedge funds set for “worst month in a decade”, says Hennessee

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Hedge funds are set to report the worst month for the industry in a decade, with the average fund down between 5 and 9 per cent in September, according to New York-based adviser to hedge f

Hedge funds are set to report the worst month for the industry in a decade, with the average fund down between 5 and 9 per cent in September, according to New York-based adviser to hedge fund investors Hennessee Group.

‘September 2008 will prove to be one of the most challenging months in the history of hedge funds,’ says the firm’s managing principal Charles Gradante, who argues that the slump in performance stems from the convergence of a variety of factors.

According to Hennessee, the restrictions on short selling put into place in mid-September by regulators in the US, UK and other jurisdictions have limited the ability of funds to effectively hedge positions and caused short squeezes, although the ban on short selling of financial stocks is expected to be temporary.

The firm notes that markets are currently driven by fear and liquidity, rather than fundamentals. Deleveraging by large institutions has led sales of core, fundamentally sound long equity positions and short covering to prop up fundamentally weak companies. This, Gradante says, has created a very challenging environment for hedge fund managers to generate alpha on either side of their portfolios.

Credit restrictions and counterparty concerns have led to additional deleveraging across the industry. Many funds are reducing the use of margin as costs have increased, and others are reducing balances at financial institutions due to concerns about counterparty risk, especially in the wake of problems for prime brokerage clients following Lehman Brothers’ bankruptcy.

Meanwhile, equity markets have experienced extreme levels of volatility and significant sell-offs, with the S&P 500 declining 9 per cent over the month and the MSCI World Index by 12 per cent. Despite funds reducing their exposure to equities, this backdrop has resulted in significant losses for funds.

In response to this difficult market, Hennessee says, hedge funds have further reduced net and gross exposure, with many sitting on significant cash balances. Many managers say they are starting to see attractive opportunities on both the long and short sides, but that they will be patient and selective before putting capital to work.

‘The significant losses in September for the hedge fund industry are disappointing, but we feel that funds performed as expected as they outperformed the broad equity markets on a relative basis,’ Gradante says.

‘The outlook for hedge funds is positive as the market dislocation should provide significant opportunities as markets return to fundamentals. Hedge funds have significant ‘dry powder’ to put to work opportunistically. This could be one of the best buying opportunities for hedge funds in a decade.’

The Hennessee Group is an investment adviser to direct investors in hedge funds on asset allocation, manager selection and ongoing monitoring of hedge fund managers. 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.

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