Short managers shine amid gloomy July for hedge funds

Date: Friday, August 17, 2007
Author: Hedgeweek.com

Hedge funds recorded on average little or no gains in July as managers suffered from sharp falls in US, European and Asian equity markets, widening credit spreads and rising oil prices. The main exception to the gloom was dedicated short bias funds, which enjoyed their best month so far in 2007 and entered positive territory for the year.

The Credit Suisse/Tremont Hedge Fund Index was completely flat with zero average performance in July, according to Oliver Schupp, president of Credit Suisse Index, while the CS/Tremont Blue Chip Investable Hedge Fund Index was down 0.88 per cent.

'Equity and credit markets reversed their bull run and fell from all-time highs in the wake of the sub-prime market fallout, with the S&P 500 dropping approximately 6 per cent between July 19 and the end of the month,' Schupp says. 'At the same time, the spread of the Credit Suisse High Yield Index over treasuries jumped to 421 basis points toward the end of July, from 271 bps at the end of May, and the price of crude oil topped USD78 a barrel.

'Markets were also affected by a currency reversal as the yen gained against the dollar. In the face of the slowdown in equity markets, US Treasury bonds rallied as investors sought more stable investments. Liquidity from overseas and the fact that inflation remained somewhat contained prevented further downward pressure during this turbulent time.'

As a result of this market environment, five of the 10 hedge fund sectors surveyed by CS/Tremont ended July in positive territory, with the dedicated short bias sector up 7.14 per cent for the month and 4.83 per cent for 2007 to date. The overall index is up by 8.7 per cent so far this year.

The HFRI Fund Weighted Composite Index from Hedge Fund Research was up by 0.45 per cent in July and 7.95 per cent for the year to date, while the HFRI Fund of Funds Composite Index is up by 0.43 and 8.32 per cent respectively. HFR's short-selling index was up by 6.49 per cent, giving the strategy a positive return for the year of 1.40 per cent, but 11 of the group's other sector indices were in negative territory. However, emerging markets returned 3.19 per cent, fixed-income arbitrage 1.63 per cent and macro 1.36 per cent.

The Hennessee Hedge Fund Index advanced by 0.33 per cent in July and is up 8.96 per cent for the year to date. 'Thus far it has been a good year for hedge funds as a whole, despite the collapse of several funds focused on fixed income,' says Hennessee Group managing principal E. Lee Hennessee. 'The increase in equity market volatility has been welcome by short sellers who have had a tough time over the past four years.'

The Hennessee Long/Short Equity Index declined by 0.12 per cent in July but is up by 8.09 per cent for the year. Short portfolios performed well, especially those focused on housing and mortgage deterioration, with lower rated tranches of sub-prime mortgage-backed indices declining by as much as 40 per cent during the month.

The widening of corporate credit spreads slowed the pace of leveraged buyout transactions, also favouring the environment for short selling, as the majority of stocks rumoured to be buyout candidates fell substantially as most lost the takeover premium embedded in their stock prices as a result of the financing concerns.

The Hennessee Arbitrage/Event Driven Index declined by 0.13 per cent but was up 7.57 per cent in 20067 to date, while the Global/Macro Index advanced 1.77 per cent and was up 12.09 per cent for the year. According to Hennessee managing principal Charles Gradante, as many macro managers benefited from short positions in sub-prime mortgages, weakness in the dollar, the increase in energy prices, and the outperformance of US by Asian stocks.

'The yen hit a three month high versus the dollar in July, which is causing some unwinding of the dollar/yen carry trade,' he says. 'There is a lot of uncertainty as to who is invested in this trade, how much is invested, and how much leverage is being used. Like 1994, there is the potential for substantial fall-out should the yen continue to strengthen.'

The RBC Hedge 250, an investible benchmark of the performance of the industry comprising more than 250 hedge funds, averaged a net decline of 0.14 per cent, according to preliminary estimates, bringing the index's year-to-date performance to 6.82 per cent. The index registered gains for fixed-income arbitrage (1.86 per cent), equity market neutral (0.73 per cent), equity long/short (0.33 per cent) and credit (0.32 per cent), while strategies in negative territory included managed futures (2.03 per cent) and convertible arbitrage (1.38 per cent)

The HFN Hedge Fund Aggregate Average, an equal weighted average of all single manager hedge funds and CTA/managed futures products in the HedgeFund.net database, was up by 0.29 per cent in July and by 7.65 per cent in the first seven months of 2007. The July increase was the second consecutive month that was positive for hedge funds although the S&P 500 was negative and the twelfth positive month in a row overall. The HFN index posted the biggest gains for emerging markets (up 2.47 per cent for the month and 14.51 per cent for the year), while distressed funds were down 2.21 per cent, managed futures by 1.42 per cent and event-driven by 1.05 per cent.

The Eurekahedge Hedge Fund Index advanced a healthy 1.3 per cent in July, the Singapore-based research firm reported, even as weakness in the credit markets lowered risk appetites and triggered sharp sell-offs in equities and high-yielding currencies towards the month's end.
Performance among regional hedge fund managers was mixed, with allocations to North America, Europe and Japan finishing the month largely flat, while allocations to the emerging markets, particularly Asia, held on to gains made earlier in the month.

With only three of the six strategies covered by Dow Jones Hedge Fund Indexes posting net of fees gains, July was the year's weakest month so far for hedge fund performance, according to Dow Jones. Merger arbitrage delivered a return of 2.45 per cent and its cumulative year-to-date return of 13.27 per cent surpassed that of equity long/short, which gained 0.58 per cent in July, pushing its return for the year to 11.93 per cent.

Convertible arbitrage gained 0.26 per cent for the month and is up 2.67 per cent for the year.
Distressed securities and event-driven fell by 1.82 per cent and 1.12 per cent respectively, but with returns of 4.75 per cent and 5.71 per cent remained up for 2007. Equity market neutral declined by 0.48 per cent in July and its performance for the year fell to 1.96 per cent.

Hedge funds gained 0.62 per cent in July, according to the Barclay Hedge Fund Index, and are up by 8.05 per cent so far this year. 'There have been well-publicised losses among a few high-profile funds that invest in sub-prime mortgages,' says Sol Waksman, the group's founder and president. 'Those losses highlighted weaknesses in the fixed-income sector and sparked a wave of selling in equity markets that sent stock prices into the loss column for July.'

Eleven of Barclay's 18 hedge fund indexes gained ground in July. The Equity Short Bias Index jumped 6.56 per cent, Emerging Markets rose 3.19 per cent, Pacific Rim Equities gained 1.67 per cent and Technology was up 1.66 per cent. 'Although we're seeing more hedge fund losses this month, the bottom line is that the overall hedge fund index and fund of funds index are positive once again,' Waksman says. 'Except for the handful of funds that blew up, the sky is not falling.' All 18 Barclay indices are up for the year, ranging from 2.12 per cent for equity short bias to 16.46 per cent for emerging markets.

Managed futures performance slid 0.59 per cent in July, according to the Barclay CTA Index. 'In many ways, July was a perfect storm for the managed futures sector,' Waksman says. 'As global equity markets experienced a sell-off, investors drove prices of US Treasuries higher in the ensuing flight to quality.' Six of Barclay's eight CTA indices lost value in July, with systematic traders down 0.72 per cent, diversified traders 0.32 per cent, financial and metals traders 0.20 per cent, and agricultural traders 0.08 per cent.

'Currency traders also came under pressure as the Japanese yen rallied sharply against other major currencies,' Waksman says. 'There's speculation that the sudden strength in the yen is the result of traders unwinding their carry trade positions.' The largest CTAs faced a difficult month, with the Barclay BTOP50 Index declining 1.70 per cent in July. The BTOP50 remains up 2.33 per cent for the year, slightly ahead of the broader Barclay CTA Index, which has gained 1.67 per cent in 2007 to date. 'Larger CTAs are often more heavily invested in the financial markets due to the greater liquidity in the sector. Smaller traders are able to keep more of their portfolio in commodities.