The Hennessee Hedge Fund Index advanced 0.20 per cent in the first half of 2010, while the broader markets had their worst half since 2008.
The S&P 500 Index decreased 7.57 per cent, the Dow Jones Industrial Average declined 6.27 per cent, and the Nasdaq Composite Index fell 7.05 per cent.
Bonds have advanced, as the Barclays Aggregate Bond Index increased 5.33 per cent year-to-date, due to increases in treasuries, investment grade and high yield bonds.
“Hedge funds experienced their fourth worse six month start since 1987, when Hennessee Group started compiling the Hennessee Hedge Fund Index,” says Charles Gradante, co-founder of Hennessee Group. “The only years with worse performance in the first six months of the year were 2008, 2002, and 1994. In 2008, the credit crisis began to unfold in the first half of the year. In 2002, poor performance was due to most hedge funds reducing short portfolios as they attempted to pick the bottom of the dot com bubble. In 1994, hedge funds experienced losses as rising global interest rates caused bond prices to plunge. In addition, hedge funds experienced significant losses attempting to unwind highly levered carry trades as liquidity disappeared.”
The Hennessee Long/Short Equity Index declined 0.14 per cent in the first six months of 2010. Long/short equity funds entered the year defensively positioned after the strong, beta driven equity rally in 2009. There was a belief that superior stock selection on both the long and short side of portfolios would provide the “edge” for managers’ performance in 2010 as fundamentals were once again expected to drive the equity markets. However, the stock market continued to be momentum driven, marching higher in the first quarter on better than expected economic data and earnings reports. The reduced exposures and hedges of long/short equity funds served as a drag on returns and led to underperformance during the first quarter.
Nonetheless, managers remained cautious into the second quarter as a slowing economic recovery and emergence of the sovereign debt crisis caused a significant equity market sell off. While long/short equity managers were largely unable to deliver positive results in the second quarter due to the broad based sell off, they did manage to outperform their traditional counterparts on a relative basis, primarily through downside protection and have now outperformed over the year-to-date period by a fairly wide margin. Managers believe valuations are beginning to look attractive after the steep sell off in the second quarter, yet they remain cautious due to the uncertain macro issues and heightened volatility in the financial markets.
The Hennessee Arbitrage/Event Driven Index has advanced 3.21 per cent year-to-date, and is the top performing sub-strategy. Multiple arbitrage funds have generated profits in several strategies, including fixed income, distressed, event driven, convertible arbitrage and merger arbitrage strategies. Fixed income portfolios have posted gains amid a positive backdrop for credit markets, as treasuries, investment grade and high yield debt are positive year-to-date.
While high yield credit spreads have widened from 639 basis points to 713 basis points, high yield bonds have generated positive performance on a total return basis, due to the positive carry. While many distressed funds retraced gains over the last two months, most remain positive year-to-date. Default rates have declined significantly, with the trailing 12-month default rate down to 5.9 per cent from 13.7 per cent at the end of 2009. Some are forecasting a 2010 full-year rate of roughly one per cent.
Merger arbitrage strategies have benefited from hedged portfolios and the closure of several strategic deals in the first half of 2010. Convertible arbitrage strategies have also generated gains due to a positive carry, low interest rates and high volatility. In addition, multiple arbitrage managers are benefiting from low interest rates, which allow them to use modest leverage at attractive costs.
The Hennessee Global/Macro Index declined 1.93 per cent in the first six months of the year. Concerns about a global economic slowdown and sovereign debt crisis in Europe remained the main focus for international markets. While international equities have declined significantly, with the MSCI EAFE Index falling 14.72 per cent, hedge funds have protected capital.
The Hennessee International Index fell only 0.02 per cent, benefiting from lower exposures and defensive positioning. The Hennessee Macro Index declined 0.40 per cent year to date. The most profitable themes have been risk aversion trades, such as gold and Treasuries, which have rallied substantially.
Many macro managers benefited from being long gold, which increased 11 per cent from USD1,121 to USD1,244 per troy ounce.
Managers suffered losses in a crowded short position in long term Treasuries. Prices of the ten Year Treasury and 30 Year Treasury increased 9.43 per cent and 15.19 per cent, respectively, as investors fled risk assets. The ten-year Treasury yield tumbled from 3.85 per cent to 2.95 per cent, falling below three per cent for the first time since April of 2009, while the 30-year Treasury yield dropped from 4.65 per cent to 3.91 per cent, below four per cent also for the first time since April of 2009.
Managers also suffered losses early in the year short the US dollar, which rose in the first six months of the year amid a flight to quality and sovereign debt concerns in Europe. Managers did however profit on short Euro positions as concerns about Greece, Spain, Italy and Portugal started to emerge and the Euro declined.
