Last month hedge funds reported the worst losses since the Morningstar Hedge Fund Index was launched in January 2003, with a decline of 7.87 per cent for the Morningstar 1000 index, more t
Last month hedge funds reported the worst losses since the Morningstar Hedge Fund Index was launched in January 2003, with a decline of 7.87 per cent for the Morningstar 1000 index, more than double the its fall in August.
According to Chicago-based investment research provider Morningstar, hedge funds entered the third quarter virtually flat for the year, but the index has subsequently fallen 13.17 per cent.
‘In September, the financial world as we know it turned upside down,’ says Morningstar hedge fund analyst Nadia Van Dalen. ‘We saw a shake-out in the hedge fund industry all around the globe. Funds experienced poor borrowing, hedging, and trading conditions while liquidity dried up and volatility skyrocketed.
‘Hedge funds were affected by extreme and unforeseen events during the month, including failures and takeovers of mortgage agencies, banks, insurers, and prime brokers. Both the Treasury Eurodollar spread – the difference between interest rates on inter-bank loans and T-bills that implies lack of market liquidity – and the Chicago Board of Options Exchange Index that measures equity volatility reached record highs.’
The Morningstar Global Equity Hedge Fund Index lost 11.22 per cent in September, the Europe Equity index declined 9.62 per cent (but outperformed the MSCI Europe Index by more than five per cent). Morningstar coyly says that its US Equity index underperformed the S&P 500 Index – which itself fell by 9.08 per cent – by more than one percentage point.
Developed Asia and emerging market equity hedge funds managed to avoid some of the market losses, on average outperforming the MSCI AC Asia Index and the MSCI Emerging Markets Index by about five percentage points. For the year to date, however, these emerging markets funds have taken more than a 30 per cent hit.
Hedging proved difficult for hedge funds in September after the Securities and Exchange Commission and Financial Services Authority announced temporary bans on shorting financial stocks. Many convertible arbitrage funds taking long positions in financial sector convertible bonds were unable to hedge with short stock positions; the Convertible Arbitrage index lost 12.39 per. However, some equity arbitrage hedge funds were able to avoid financials, and the Equity Arbitrage index lost only 4.60 per cent.
Debt-oriented hedge funds also experienced hedging problems. Credit default swaps, a common way to hedge bond exposure, became more expensive and less attractive with fears of default and counterparty risk.
Both the Debt Arbitrage and the Global Debt indices underperformed global and US bonds, losing 4.39 per cent and 7.50 per cent respectively. The Distressed Securities index closed the month down 6.21 per cent as risky debt yields rose.
Global trend-following hedge funds profited from some of the downward trends in the market, as these funds trade stock index futures as well as interest rates, currencies and commodities. The Global Trend index lost only 1.26 per cent, the best-performing category other than short equity. The Global Non-Trend index, comprising funds with a more macro-economic approach, slid by just 1.56 per cent.
Funds of funds performed in line with the Morningstar 1000 index, outperforming it by about 20 basis points in September but falling slightly short for the quarter and year to date. The Multistrategy index underperformed the overall index by about 200 basis points.
The returns are based on hedge funds in the Morningstar indices that had reported performance by October 12. Morningstar has around 8,500 hedge funds and funds of hedge funds in its database. The firm recently launched the Morningstar 1000 Hedge Fund Index, a representative benchmark for hedge fund performance composed of the top 90 per cent of eligible assets in the hedge fund database.
