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Hedge funds rebound in February, say index providers

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Hedge fund index providers have reported a recovery in performance for most hedge fund strategies in February following the previous month’s losses, even as equity markets continued to fal

Hedge fund index providers have reported a recovery in performance for most hedge fund strategies in February following the previous month’s losses, even as equity markets continued to falter amid turbulence in the credit markets and growing fears of a US recession.

The Hennessee Hedge Fund Index rose by 1.28 per cent in February, the RBC Hedge 250 Index had a net return of 1.31 per cent, and the Barclay Hedge Fund Index gained 1.58 per cent, while four of the six hedge fund strategies covered by the Dow Jones Hedge Fund Indexes were up for the month.

Two providers reported a more substantial upturn in performance – the Greenwich Global Hedge Fund Index returned 2.21 per cent, while the HFN Hedge Fund Aggregate Average, an equal-weighted benchmark of all single-manager hedge funds and CTA/managed futures products in the database, returned no less than 2.93 per cent.

For most index providers, however, February’s performance signalled cautious recovery rather than an end of the industry’s woes. ‘While it was a reasonable month for long/short equity funds, it continues to be an extremely difficult market for fixed income funds,’ says Lee Hennessee, managing principal of Hennessee Group. ‘Several fixed-income funds focusing on investment-grade mortgages and municipal bonds have faced margin calls and been forced to sell assets unwillingly.’
Short portfolios’ better protection
The Hennessee Long/Short Equity Index advanced 0.93 per cent in February but remains down 2.44 per cent for 2008. The firm says funds were able to benefit from the increase in volatility in February, when short portfolios also acted as a better hedge, providing protection from the market’s decline.

While most long/short equity managers are finding a number of attractively priced opportunities, Hennessee says, most recognise that the market’s poor liquidity will likely drive prices in the short term and potentially allow for purchases at lower levels.
‘It’s likely that AIG’s write-off within its credit default swap portfolio will be followed by similar write-offs by many of the large banks,’ says Charles Gradante, Hennessee Group’s other managing principal.

‘Banks may have another USD200bn to write off as the result of being on the wrong side of this trade if they mark these contracts to market. Furthermore, the commercial real estate market is showing signs of weakness due to over-levered real estate investors.’
The Hennessee Arbitrage/Event Driven Index advanced gained 0.34 per cent in February, and the Hennessee Distressed Index 0.79 per cent. While spreads widened in most areas of corporate debt, Hennessee says, many credit-oriented funds posted positive returns as yields started to reach attractive levels to compensate for widening spreads.

Hostile technology and commodity bids
The Hennessee Merger Arbitrage Index declined by 0.56 per cent for the month. While strategic merger and acquisition activity picked up with several high-profile hostile deals in the technology and commodity sectors, merger spreads were generally weaker because of high equity volatility. While hung LBO deals are slowly being completed, most continue to have difficulty obtaining attractively priced financing.

The Hennessee Convertible Arbitrage Index fell by 0.56 per cent. Despite the market’s sell-off, implied volatility as measured by the VIX was virtually flat for the month, while credit spreads widened. Many funds are starting to find more attractive opportunities within convertibles as a result of the strategy’s poor performance in 2007.
‘Macro managers are diversifying their agricultural portfolios to include major positions in sugar because, on an inflation-adjusted basis, sugar is the cheapest commodity and more cost-effective than corn in producing ethanol,’ Gradante says.
The Hennessee Global/Macro Index gained 2.55 per cent last month. After struggling in January, international equities and international long/short equity funds outperformed their US counterparts in February. The Hennessee International Index returned 2.51 per cent as both the MSCI Europe and MSCI Asia-Pacific indices posted positive returns for the month, for now escaping the economic weakness in the US.

The Hennessee Macro Index rose by 3.92 per cent for the month as almost every theme common among macro funds posted positive returns. Commodities (especially oil, gold, platinum, grains) were strong throughout the month, the US yield curve steepened, the dollar declined against both the euro and yen, and emerging market equities outperformed their US counterparts.

Multistrategy funds struggle again
The 1.31 per cent gain for the RBC Hedge 250, according to preliminary returns, left the index still down 0.73 per cent for the first two months of 2008 after the investible benchmark’s decline in January was finalised at 2.01 per cent. The RBC index comprises more than 250 hedge funds from a universe of 5,877 funds with aggregate assets of USD1.63trn.

The index’s top performing strategies were macro, which rose 3.57 per cent in February to reach 6.09 per cent for the year so far, and managed futures, which was up by 4.91 and 8.24 per cent respectively.

Equity long/short and mergers and special situations gained 2.04 per cent and 1.96 per cent last month but remain down for 2008, while convertible arbitrage and fixed-income arbitrage lost 0.27 and 0.29 per cent respectively in February. Multistrategy funds fell 1.38 per cent last month and are down 3.67 per cent for the year, more than any other strategy.

The HFN Hedge Fund Aggregate Average has risen by 0.26 per cent so far in 2008 even as the S&P 500 total return index has declined by 9.06 per cent, the largest outperformance by hedge funds at the beginning of a year since 2000.

HFN says hedge fund returns were supported in February by very strong commodity prices virtually across the board, a recovery in emerging markets and savvy short exposure from long/short equity managers. It identifies a growing divergence in hedge funds returns between funds caught in the middle of the credit market’s troubles and those benefiting from the environment created by attempts to solve the issues.

Commodity-focused managers, the index provider says, are benefiting greatly from US monetary policy, which is more focused on liquidity than limiting inflation. The HFN CTA/Managed Futures Average was up 8.95 per cent in February, 10.96 per cent so far in 2008 and 24.9 per cent over the past 12 months.

Macro funds benefit from shifting market dynamics
The relative decline in value of the dollar and growing interest rate differentials between US Treasuries and various sovereign rates have helped macro funds take advantage of shifting global market dynamics. The HFN Macro Average was up 3.41 per cent in February and 2.91 per cent in 2008 to date, the highest beginning-of-year outperformance over broad hedge fund returns since 1997, when the average macro fund went on to return 24.23 per cent.

Both emerging markets and energy sector funds bounced back after large January losses. The HFN Emerging Markets Average was up 3.60 per cent and the HFN Energy Sector Average gained 2.65 per cent, although they remain down for the year by 1.56 and 3.63 per cent respectively.

For the second month, long/short equity managers were able to add protection during a market decline, with the HFN Long/Short Equity Average rising 2.03 per cent. The HFN Market Neutral Average was up 1.40 per cent in February and 0.23 per cent so far in 20008, while the HFN Short Bias Average gained 4.43 per cent in February for a cumulative 9.24 per cent so far this year.

Arbitrage strategies in fixed-income markets appear to have been most negatively affected by credit market disruptions. The HFN Fixed Income Arbitrage Average was down 0.41 per cent, while the HFN Convertible Arbitrage and Capital Structure Arbitrage averages fell by 2.74 per cent and 4.72 per cent respectively.

Four of the six hedge fund strategies covered by Dow Jones Hedge Fund Indexes posted positive returns for February, led by merger arbitrage and equity long/short with net-of-fees gains of 1.95 per cent and 1.49 per cent respectively. However, merger arbitrage is the only strategy with gains for the year so far, and equity long/short has lost 4.67 per cent in the first two months of the year, the worst performance of any strategy.

Distressed securities in distress
Dow Jones’ event-driven and equity market neutral strategy benchmarks posted returns of 0.86 per cent and 0.63 per cent respectively, while convertible arbitrage posted a loss of 0.02 per cent and is down 0.24 per cent for the year. Distressed securities continued to decline, losing 0.51 per cent in February and bringing its year to date loss to 4.01 per cent.

‘After falling 3.24 percent in January, hedge funds regained some ground in February,’ says Sol Waksman, founder and president of BarclayHedge, whose Barclay Hedge Fund Index gained 1.58 per cent. ‘Although US equity markets declined in February, equity-based hedge fund strategies were still able to post profits for their investors.’

Overall, 16 of Barclay’s 18 hedge fund indexes rose in value. The Equity Short Bias Index jumped 6.25 per cent, Global Macro gained 3.81 per cent, Emerging Markets were up 2.48 per cent, Event Driven rose 2.39 per cent, European Equities were up 1.99 per cent, and Distressed Securities gained 1.89 per cent.

‘At this point, 74.4 per cent of the hedge funds that have submitted a February return are reporting a profit,’ says Waksman. ‘This represents a major turnaround from January when 77.6 per cent of funds reported losses.’ The only strategies down in February were convertible arbitrage, which fell 2.50 per cent, and healthcare and biotechnology, down 1.43 per cent.

The Greenwich Global Hedge Fund Index returned 2.21 per cent in February, rebounding from January’s decline of 2.79 per cent, the worst since 2002, as all hedge fund strategy groups ended the month with gains. ‘February’s rebound in the midst of market uncertainty continues to highlight the diversification benefits of hedge funds,’ says Greenwich managing director Margaret Gilbert.

Directional trading’s 5.48 per cent return was driven largely by futures managers who capitalised on volatile commodities markets, while long/short equity managers also benefited from choppy equity markets, gaining 1.28 per cent. For the second month in a row, dedicated short sellers were the top performers in this group, gaining 4.12 per cent.

Greenwich’s specialty strategy group returned 2.74 per cent on average, led by emerging markets, which rebounded 4.4 per cent after its January decline, while market neutral funds managed an average return of 1.11 per cent. The Greenwich Composite Investable Hedge Fund Index enjoyed a 1.05 per cent return in February.

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