Guest post from the Hennessee Group.
HEDGE FUNDS DECLINE -3.36% IN AUGUST
Hedge Funds Suffer Worst Loss in Over a Year
September 8, 2011 – New York, NY – Hennessee Group LLC, an adviser to hedge fund investors, announced today that the Hennessee Hedge Fund Index declined –3.36% in August (-1.80% YTD), while the S&P 500 declined -5.68% (-3.08% YTD), the Dow Jones Industrial Average fell -4.36% (+0.31% YTD), and the NASDAQ Composite Index decreased -6.42% (-2.78% YTD). Bonds were mixed, as the Barclays Aggregate Bond Index advanced +1.46% (+5.90% YTD) and the Barclays High Yield Credit Bond Index fell -4.00% (+1.95% YTD).
“August was a very challenging month for hedge funds as they were once again ‘whipsawed’. Hedge funds were forced to reduce exposure in order to limit losses as the financial markets plummeted. They then underperformed as the markets rallied back strongly into month end,” commented Charles Gradante, Co-Founder of Hennessee Group. “Markets continue to be driven by fear, resulting in high correlation among asset classes. The result is one of the most challenging investment environments for hedge funds on record since inception of the Hennessee Hedge Fund Indices in 1987.”
“Hedge funds experienced their worst loss in August since October 2008. Directional strategies, such as long/short and event driven, were the hardest hit, while short biased and macro funds were the best performing strategies,” commented Lee Hennessee, Managing Principal of Hennessee Group. “For the year, hedge funds are down about -2% on average, but that masks the wide dispersion in individual hedge fund manager returns.”
The Hennessee Long/Short Equity Index declined -3.68% (-1.65% YTD) in August, its fourth consecutive negative month. August was a turbulent month in the equity markets as the S&P 500 declined -5.68% for the month and was down as much as -17% during the month. The combination of slowing global growth, intensifying European sovereign debt issues, the U.S. debt downgrade, and disapproval with the political process triggered a sharp selloff. Momentum selling exacerbated losses, resulting in a slow motion market crash. While a month end rally relieved some of the losses and masked monthly volatility, investor confidence was shaken and the likelihood of a double-dip recession has increased. This environment has been extremely challenging for hedge funds as the correlation between assets has increased to almost 80%, surpassing levels seen during the credit crisis of 2008. During the month, losses in many core positions were exacerbated as many hedge funds had overlapping holdings. Managers responded by taking down exposure levels and increasing their cash balance. Managers also shifted to higher quality, large cap names and traded out of more economically sensitive names for more recession-resistant ones. In addition, managers are using a variety of tools to hedge downside risk, while trying to maintain the ability to participate if we were to experience a sharp rally.
“The political stalemate and resulting uncertainty has become a major issue for the financial markets. The inability for the U.S. political system to make progress has caused consumer and corporate confidence to decline significantly,” commented Charles Gradante. “As a result, individuals and businesses are reluctant to spend, hire, or invest. While a recession seemed unlikely a few weeks ago, the probability of another recession has meaningfully increased over the last month.”
The Hennessee Arbitrage/Event Driven Index declined in August, falling -2.98% (-0.79% YTD). Bonds were mixed as investors sold risky assets and fled into safe havens. U.S. Treasuries benefited from the flight to quality and yields declined substantially, while investment grade and high yield spreads increased substantially in August. Trading in the high yield market, which is seasonally slow in August, was essentially non-existent. The limited liquidity was challenging for managers looking to reduce risk in the declining market, helping to exasperate mark-to-market losses. Managers responded by adding short exposure in highly liquid instruments in order to protect capital. That said, after a painful August, managers are selectively adding to attractive opportunities, but remain cautious. The Hennessee Distressed Index decreased -6.01% in August (-2.22% YTD). Distressed managers suffered significant losses as investors increased risk aversion in a flight to quality. Core long positions declined more than the market as investors sold risky assets indiscriminately. Hedges provided some relief, but distressed managers were hurt by their traditional long bias. Managers also suffered from a lack of catalysts as tumultuous markets prevented companies from pursuing refinancing, IPOs and other events. The Hennessee Merger Arbitrage Index declined –1.77% in August (+0.31% YTD). Merger arbitrage mangers experienced losses as spreads in even the most solid merger arbitrage transactions widened dramatically. As a result, managers are finding opportunities to selectively add to positions at very attractive levels. The Hennessee Convertible Arbitrage Index returned -1.95% (+0.60% YTD) in August. Convertible securities sold off along with other risk assets. As a result, the Merrill Lynch CB index cheapened to 0.52%. There was no new issuance.
“Long positions in gold have been a key source of profits for hedge funds this year. Despite the strong performance this year, managers continue to be bullish on gold,” commented Charles Gradante. “As the developed economies approach a period when they cannot issue new debt and cannot raise taxes, the only option is to print money, which is bullish for gold.”
The Hennessee Global/Macro Index declined -2.91% in August (-3.07% YTD). Negative macroeconomic data, widening sovereign credits in Europe, and the S&P downgrade of U.S. debt drove markets lower and set an extremely negative tone for the month. Financial markets across the globe declined with the MSCI All-Country World Index falling -7.53% in August (-6.05% YTD). Europe was hit especially hard as the Euro Stoxx 50 ended the month down -13.8% and was down -22% at its month low. International hedge fund managers experienced losses as the Hennessee International Index declined -5.97% (-4.43% YTD). Emerging markets also fell as the MSCI EM Index declined -9.19% (-10.27% YRD). Hedge fund managers outperformed as they were positioned cautiously with the Hennessee Emerging Markets Index falling -3.30% (-2.18% YTD). Managers remain optimistic on emerging markets long term as many have stronger balance sheets, higher growth, and increasing consumption. The Hennessee Macro Index was one of the best performing indices, advancing +0.60% in August (+0.11% YTD). The flight to quality resulted in losses to almost all asset classes except for precious metals. Gold was a top performer in August, up +12.2%, while silver (+4.2%) and platinum (+3.7%) also performed well. In terms of currencies, the conflicting headwinds of greater risk aversion versus the U.S. downgrade by S&P resulted in the U.S. Dollar remaining largely range bound in August (+0.3%). Managers did experience losses in their long Swiss Franc positions on intervention by the Swiss National Bank. Oil was also weak given the fears around slowing global growth and pending resolution of the Libyan civil war.
* For a more in depth monthly review of the economy, capital markets, and hedge fund performance and strategies, the Hennessee Group offers the monthly Hennessee Hedge Fund Review (www.hennesseegroup.com/hhfr/ <http://www.hennesseegroup.com/hhfr/> ).