Tue, 09/03/2010 - 10:40
The Hennessee Hedge Fund Index advanced 0.96 per cent in February, bringing its year-to-date performance to 0.42 per cent.
The S&P 500 increased 2.85 per cent in February (-0.95 per cent YTD), while the Dow Jones Industrial Average advanced 2.56 per cent (-0.99 per cent YTD) and the Nasdaq Composite Index advanced 4.23 per cent (-1.36 per cent YTD).
Bonds rallied with the Barclays Aggregate Bond Index increasing by 0.37 per cent (+1.91 per cent YTD).
“Global equity markets were mixed in February, with the US experiencing gains and most international markets posting small losses. During the month, the focus of hedge fund managers was on Greece and its debt level, as well as potential problems in Spain, Portugal and Italy,” says Charles Gradante, co-founder of Hennessee Group. “Some managers see this only as the tip of the iceberg. Managers fear a downgrade or threat of downgrade for a G12 country’s sovereign debt that could potentially unravel the markets.”
The Hennessee Long/Short Equity Index advanced 1.48 per cent in February (+0.36 per cent YTD). January’s sharp sell-off reversed course in mid-February as investors cheered reports that the European Union was considering helping the debt-laden Greek government to avoid default and reduce the risk of another global financial crisis.
Hedge fund managers were encouraged but not yet convinced by the stronger than expected earnings reports and encouraging economic data that was released in the second half of the month. Managers took note of the solid equity gains, led by the Russell 2000 Index (small cap stocks) and the Russell Mid Cap Index, which rose 4.4 per cent and 4.8 per cent, respectively, indicating a favourable increase in the market’s appetite for risk.
Cyclical stocks led the way confirming managers’ views that the market became less risk averse, particularly consumer discretionary stocks which gained a strong 5.3 per cent in February. The intra-month volatility made for a challenging trading environment for long/short equity funds and led to mixed results.
The Hennessee Long/Short Equity Index slightly lagged the broader equity markets. Going forward, long/short equity managers will remain cautious and selective due to the uncertainty surrounding the strength of the economic recovery and growing concern that sovereign default risks could become a global problem.
“Long/short equity funds state that they are encouraged by market breadth witnessed during the recent earnings season,” says Gradante. “Managers like the dispersion they are seeing among stocks. Companies that report good earnings or increase guidance are rewarded, while companies that fail to meet expectations are being punished. This was not the case in 2009 when momentum ruled. This is a better environment for long/short stock picking based upon fundamental research and should bode well for alpha generation through 2010.”
The Hennessee Arbitrage/Event Driven Index advanced 0.76 per cent in February (+1.56 per cent YTD). US corporate credit markets registered a positive month, with leveraged loans and high yield credit posting small gains. Credit spreads actually widened during the period, though were positive on a total return basis. Volatility increased in February, as spreads started the month at 654 basis points, widened to 700 basis points mid-month, but retraced at the end of the month and finished February at 671 basis points. Capital markets issuance continued at a high rate, raising USD11.8bn.
The Hennessee Distressed Index increased 0.76 per cent in February (+2.88 per cent YTD). Distressed managers suffered during the beginning of the month as credit spreads widened, but were able to recoup losses and post modest gains. Generally, the distressed markets continue to present ample long and short opportunities for investors. Managers believe that the significant corporate maturities that come due in 2012-2014 will prove problematic to refinance and will provide investment opportunities.
The Hennessee Merger Arbitrage Index advanced 0.52 per cent in February (+0.92 per cent YTD). Managers continue to believe that M&A activity will pick up due to the lack of economic growth in the US and Europe, and the need for companies to manufacture higher revenues. Managers note that big pharma companies have large cash levels and are able to make acquisitions without financing dependence. Merger arbitrage managers continue to invest in large announced deals, including Affiliated Computer/Xerox, Burlington North/Berkshire, XTO/Exxon Mobile, and Cadbury/Kraft.
The Hennessee Convertible Arbitrage Index returned 0.14 per cent (+0.45 per cent YTD). Spreads and volatility detracted from performance, while secondary market richening, positive cash flows and interest rates made positive contributions in February. The US convertible market showed continued weakness in February with little issuance and significant redemptions. The new issues that came to market were generally not well received.
The Hennessee Global/Macro Index increased 0.32 per cent in February (-0.60 per cent YTD). International equities declined with the MSCI EAFE Index falling 0.88 per cent (-5.28 per cent YTD) during the month. Willingness to assume risk remained subdued due to fears about the sustainability of global growth, particularly with the state of the developed world’s balance sheets in Greece, Italy, Ireland, Portugal, and Spain. In emerging markets, managers are concerned about a possible return of inflation in China, India, and Brazil.
The Hennessee International Index gained 1.24 per cent (-0.04 per cent YTD) as managers maintained low net exposures and benefited from US exposure. The Hennessee Macro Index advanced 1.97 per cent for the month (+1.59 per cent YTD).
Managers experienced gains in commodities, especially gold and crude oil, which snapped back after losses in January. Many are optimistic on commodities long term, but believe there will be volatility short term as the pace of the global recovery is called into question.
In currencies, Hennessee Group research concluded that many hedge funds have become bearish against the euro in February. This is further supported by a Morgan Stanley report stating that the size of the bearish bet against the euro, by all institutions, not just hedge funds, has reached the highest level since 1999. Managers are also long the Chinese Yuan, believing that China will have to raise interest rates and address its currency undervaluation.
“Many hedge funds are growing more bearish against the euro. Some believe that the euro is likely to continue to decline, potentially falling to parity with the dollar,” says Gradante. “Recently, there has been a big deal made about hedge funds meeting to discuss this trade, even stating that hedge funds attempted to collude to drive down the price of the euro. Given that the euro trades approximately USD1.2trn per day, it is highly unlikely that a group of hedge funds could conspire to manipulate the currency.”
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