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Hedge funds protect capital and outperform as markets decline sharply

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Hedge funds have been able to protect capital and generate modest positive performance this year despite high levels of volatility and declines in the equity markets, research by Hennessee Group shows. 

The Hennessee Hedge Fund Index declined 0.49 per cent in August  and is up 1.30 per cent year-to-date.

Lee Hennessee, managing principal of Hennessee Group, says: “In addition, many managers have an optimistic outlook on their ability to make money long and short, and feel that they are starting to be rewarded for their fundamental research on both a relative and absolute basis. However, given the skittishness of the markets and potential for extreme volatility, managers remain cautious and well hedged.”

The Hennessee Long/Short Equity Index declined 0.99 per cent in August (+0.18 per cent YTD). Long/short equity funds outperformed traditional benchmarks on a relative basis due to reduced exposure levels and a positive spread between the performance of long and short portfolios. After the strong gains of July, stocks retreated in August as investors digested a series of weak economic data points that suggested a double dip recession may not be entirely out of the question.

All the major equity market indices declined in August, led by the Russell 2000Index (small cap stocks) which dropped 7.50 per cent (-3.72 per cent YTD), its worst August in 12 years. 

Sector performance in August was far more varied than the broad based gains experienced in July with financials (-7.8 per cent), industrials (-7.0 per cent), and technology (-7.0 per cent) faring the worst, while defensive oriented sectors, such as healthcare (+4.0 per cent), telecommunications (+2.3 per cent) and utilities (+1.5 per cent), holding up the best. 

Arbitrage and event driven managers were essentially flat in August, as the Hennessee Arbitrage/Event Driven Index declined 0.04 per cent (+4.55 per cent YTD).

During the month, fixed income markets continued to display strong positive performance as the Barclays Aggregate Bond Index advanced 1.29 per cent (+7.83 per cent YTD) and the BofA Merrill Lynch US High Yield Index increased 0.16 per cent (+8.54 per cent YTD). High yield spreads widened slightly amid a flight to quality. The Hennessee Distressed Index fell 1.12 per cent in August (+5.14 per cent YTD). Managers experienced losses as equity markets declined and spreads widened. 

The Hennessee Merger Arbitrage Index advanced 0.90 per cent in August (+3.41 per cent YTD). Merger arbitrage was one of the best performing strategies in August as the markets witnessed a flood of deal activity. Hedge funds benefited from the bidding war that unfolded between Hewlett Packard and Dell for 3Par. In addition, managers were encouraged by Intel’s proposed take over of McAfee, BHP Billiton’s offer for Potash, and Sanofi’s offer for Genzyme. Managers expect acquisitions to continue as companies have large cash balances. 

The Hennessee Convertible Arbitrage Index advanced 0.72 per cent (+3.91 per cent YTD) in August. Convertible arbitrage portfolios benefited from a positive carry, increasing volatility, and lower interest rates, while a widening of spreads detracted slightly from performance. In addition, managers who were hedged benefited as the equity markets declined sharply. Cross over and outright buyers remain supportive of convertible valuations, especially as investors continue to pursue yield.

The Hennessee Global/Macro Index advanced 0.11 per cent in August (0.19 per cent YTD). As has been the case throughout 2010, the developed equity markets were the laggards during the month with the MSCI World Index down 3.9 per cent (-7.5 per cent YTD) while the MSCI Emerging Markets Index was off 2.1 per cent (-2.0 per cent YTD). Notable decliners during the month included Ireland (-15.4 per cent), Greece (-9.3 per cent) and Italy (-7.5 per cent). 

International managers outperformed due to reduced exposures levels, strong region and stock selection, and overweight exposure to emerging markets. The Hennessee International Index advanced 1.40 per cent for the month (+0.61 per cent YTD). The Hennessee Macro Index advanced 0.87 per cent for the month (+0.02 per cent YTD).

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