The Hennessee Hedge Fund Index advanced 3.50 per cent in September and is now up 4.60 per cent year-to-date.
The S&P 500 advanced 8.76 per cent (2.34 per cent YTD), the Dow Jones Industrial Average increased 7.72 per cent (3.45 per cent YTD), and the Nasdaq Composite Index climbed 12.04 per cent (4.38 per cent YTD).
Bonds also advanced, as the Barclays Aggregate Bond Index increased 0.11 per cent (7.94 per cent YTD).
“Hedge funds had their best month since May of 2009 and continue to outperform the broad market year to date,” says Charles Gradante, co-founder of Hennessee Group. “While managers are concerned about elevated macro economic risks, we are beginning to see growing optimism about the equity markets in the short term. The Federal Reserve is determined to create growth and inflation, benefiting equities, which look attractive relative to other asset classes.”
The Hennessee Long/Short Equity Index advanced 3.91 per cent in September (3.71 per cent YTD).
Hedge funds posted the strongest monthly gain since May 2009 as equity markets surged on renewed investor confidence in the global economic recovery. While the S&P 500 Index experienced its best September gain since 1939, small cap stocks continued to lead the markets with the Russell 2000 Index increasing an impressive 12.3 per cent during the month (8.1 per cent YTD). All ten sectors experienced gains during the month led higher by technology, which continues to benefit from favourable fundamentals, increasing M&A activity and higher buybacks. Hedge funds participated in the market rally, but lagged on a relative basis due to reduced exposures and hedges.
Short selling was particularly difficult for hedge funds as 97 per cent of the S&P 500 constituents experienced gains during the month. Short biased managers suffered from the equity rally, losing 7.02 per cent during the month and are now down 7.37 per cent for the year. As the markets appear to have stabilised, hedge funds have modestly increased exposure levels, but remain cautious given the likelihood of a near term pullback. While managers have long term macro concerns, many are getting bullish in the short term as the Federal Reserve is determined to increase growth and inflation with quantitative easing, which should benefit risk assets. With the S&P 500 trading at a P/E of 13.8x forward earnings, managers see value in the equity markets, but feel security selection is paramount as there will likely be greater dispersion in performance as third quarter earnings are released and comps relative to last year become tougher.
Arbitrage and event driven managers were positive in September, as the Hennessee Arbitrage/Event Driven Index advanced 2.66 per cent (7.15 per cent YTD).
During the month, fixed income markets were positive as the Barclays Aggregate Bond Index advanced 0.11 per cent (7.94 per cent YTD) and the BofA Merrill Lynch US High Yield Index increased 2.97 per cent (11.76 per cent YTD), while Treasury prices declined as investors increased risk appetites.
Spreads tightened in September, with investment grade bonds reaching 184 basis points and high yield reaching 629 basis points, levels not seen since May. Managers remain constructive on the high yield space. Spreads remain wide relative to historical averages, fundamentals are improving, balance sheets are strong, and default rates are declining.
The Hennessee Distressed Index increased 2.38 per cent in September (7.13 per cent YTD). Distressed managers experienced gains as equity markets rallied sharply and credit spreads tightened. While default rates are expected to decline significantly, managers report that if the economic recovery is muted, we could see an extension of the distressed cycle as stressed companies are unable to refinance maturities and are forced into bankruptcy, especially in light of the daunting wall of maturities approaching in 2012 to 2015.
The Hennessee Merger Arbitrage Index advanced 0.41 per cent in September (3.83 per cent YTD). Managers were positive as deal spreads tightened slightly, but underperformed other strategies due to a high hedge ratio. Managers are encouraged by the recent acceleration in deal activity, as third quarter M&A activity was up 26 per cent from the second quarter. Corporations are starting to spend more aggressively on strategic acquisitions, which should continue to create new investment opportunities.
The Hennessee Convertible Arbitrage Index advanced 2.83 per cent (7.27 per cent YTD) in September. The convertible bond market continued to rally through September, although lagged the equity market. Valuations improved and new issuance started to pick up after a quiet summer. Convertible portfolios were positive due to higher prices and positive cash flow, which were partially offset by losses on short equity positions. Managers are optimistic on convertible bonds as valuations remain attractive, while the equity markets appear vulnerable to a correction.
