The Hennessee Hedge Fund Index advanced 3.05 per cent in March, bringing the return for the year to date to 3.50 per cent.
The S&P 500 increased 5.88 per cent in March (4.87 per cent YTD), while the Dow Jones Industrial Average advanced 5.15 per cent (4.11 per cent YTD) and the Nasdaq Composite Index advanced 7.14 per cent (5.68 per cent YTD).
Bonds fell slightly, as the Barclays Aggregate Bond Index decreased 0.12 per cent (+1.78 per cent YTD).
“The financial markets seem to have quickly forgotten about sovereign risk and concerns about central bank exit strategies. Investors remain willing to assume greater levels of risk, and equity markets rallied sharply in March,” says Charles Gradante, co-founder of Hennessee Group. “However, as the second quarter begins, hedge fund managers are generally cautious. Their key concern is that the Fed is moving forward with its plans to end and eventually reverse its easing of credit.”
The Hennessee Long/Short Equity Index advanced 3.07 per cent in March (3.45 per cent YTD). The equity markets continued to move higher in March, erasing losses from earlier in the year and leading to broad based gains for most major market indices in the first quarter.
A solid earnings season coupled with additional data points suggesting that a sustainable economic recovery could be in place served as the primary catalysts for the equity markets and led to a number of indices reaching 18 month highs. All ten sectors were positive for the month, led by industrials (8.9 per cent), and financials (8.8 per cent).
The positioning of long/short equity funds heading into the month was largely defensive as concerns regarding a near term correction mounted and resulted in the majority of funds lagging during the broad based equity rally in March. During the month, hedge funds took profits on long positions, resulting in lower exposures at month end. Managers also express frustration with short portfolios as they continue to be a drag on performance.
Small cap stocks led the equity markets higher with the Russell 2000 Index leaping a strong 8.0 per cent. Many funds shifted to small caps in recent weeks and that has helped many drive strong returns.
While sentiment has clearly improved, there is concern that much of the positive news is already priced into the markets and the direction of stocks going forward is highly uncertain. Given the near term uncertainty, long/short equity funds will remain cautious with lower net exposures while emphasizing individual security as the primary alpha generator in 2010.
“Some managers are worried that the velocity of money is collapsing. Velocity of money is a measure of how many times a dollar is re-used in the economy. According to managers, this ratio peaked in 1997 near the top of the dotcom bubble and has been in decline ever since. Some interpret this to signal the end of ‘a 50 year super cycle in lending’,” says Gradante. “Since lending has been a key driver of economic growth over the past decades, this points to more muted growth over the long term. Managers state that this is partly the result of banks refusing to lend and are closely monitoring the banking industry.”
The Hennessee Arbitrage/Event Driven Index advanced 3.10 per cent in March (4.72 per cent YTD). US corporate credit markets declined slightly as the Barclays US Aggregate Bond Index fell 0.12 per cent in March. Losses were driven by Treasuries, especially on the longer end of the curve, while investment grade and high yield bonds were positive for the month.
The spread on the Merrill Lynch High Yield Index tightened from 671 basis points to 584 basis points during the month. Spreads have significantly tightened over the past 12 months but remain wide by historic standards. New debt issuance remains extremely strong, with more than USD31bn in new high yield debt coming to market in March, surpassing the November 2006 monthly record. Managers remain optimistic on credit, but are assuming less directional risk by adding to hedges.
The Hennessee Distressed Index increased 5.32 per cent in March (8.37 per cent YTD). March was another positive month for distressed funds as credit spreads tightened and several companies emerged from bankruptcy. Generally, the distressed markets continue to present ample long and short opportunities for investors. Managers believe slow economic growth going forward will prove challenging for many companies and industries. In addition, many are looking forward to 2012 to 2014 when a daunting corporate maturity schedule should prove problematic to refinance and will provide investment opportunities.
The Hennessee Merger Arbitrage Index advanced 1.96 per cent in March (2.90 per cent YTD). Despite manager expectations for a rise in M&A activity in 2010, deal activity has been relatively unimpressive. In the first quarter, global M&A activity totalled USD650bn, up only 14 per cent from the first quarter of 2009. While there have been several large announced deals, including two in March related to AIG, there has not been much activity in mid-sized companies. However, managers remain optimistic that activity will accelerate as companies have significant cash balances, which needs to be put to work.
The Hennessee Convertible Arbitrage Index returned 3.00 per cent (3.60 per cent YTD). Convertible securities increased in March as investor confidence improved and the sector finally saw significant new issuance. In addition, credit spreads tightened, benefiting managers.
“Managers report that undistributed corporate profits hit an all-time high of USD527bn at a seasonally adjusted annual rate. In addition, according to a Strategas report, non-financial companies in the S&P 500 have a record USD830bn of cash on their books,” says Gradante. “Many believe that these cash stockpiles could lead to a pick up in mergers and acquisitions, which could serve as a catalyst for higher prices as it did in 2006 and 2007.”
The Hennessee Global/Macro Index increased 3.14 per cent in March (2.49 per cent YTD). International equities rallied with the MSCI EAFE Index climbing 5.81 per cent (0.22 per cent YTD) during the month. Gains were broad based, with emerging markets performing very strongly.
The Hennessee International Index gained 2.89 per cent (2.78 per cent YTD) as managers had conservative exposures. During the month, international managers decreased their US equity exposure in favour of international markets.
The Hennessee Macro Index advanced 1.12 per cent for the month (2.64 per cent YTD). Managers generated gains on commodity bets, including oil and copper. Oil prices advanced in March, and have posted their fifth consecutive quarterly gain. Copper prices, a common long bet, gained eight per cent during the month.
Managers generated gains short Treasuries as yields rose sharply, especially on the longer end of the yield curve. This remains a common theme in the industry with many funds heavily invested in a US curve steepening trade. Managers also remain short the Euro and Yen in favour of the US dollar.
