Hedge funds decline 6.24 per cent in worst month since 1998, says Hennessee

Date: Friday, October 10, 2008
Author: HedgeWeek

The Hennessee Hedge Fund Index declined by 6.24 per cent in September, the worst month for the industry since August 1998, and is now down by 10.28 per cent over the first nine months of this year, according to Hennessee Group, a provider of industry data and adviser to hedge fund investors.

'Despite being defensively positioned, September was the worst month for hedge funds in over a decade,' said the firm's co-founder Charles Gradante. 'The ban on short selling caused significant losses across most strategies and required funds to alter their trading models.'

Managing principal Lee Hennessee adds: 'Hedge funds have outperformed on a relative basis this year to date. However, given their reduced exposures over the first nine months of the year, I would expect hedge funds to be down less. Violent theme reversals, extreme volatility and unpredictable intervention have contributed to negative performance.'

The Hennessee Long/Short Equity Index declined by 5.86 per cent in September and is down 9.31 per cent so far this year. The majority of losses came in the last two weeks of the month as the US and other authorities decided to restrict short selling and liquidity disappeared.

The intervention created a massive short squeeze, while long positions were pushed lower by deleveraging and liquidity concerns. Managers have further reduced net and gross exposure as the markets continue to respond to fear and liquidity, rather than fundamentals.

'Convertible arbitrage portfolios faced massive mark-to-market losses' Gradante says. 'The short-selling ban, financial defaults and forced selling resulted in a sharp decline in prices. However, the dislocation has created convertible opportunities as attractive as they have ever been.'

The Arbitrage/Event Driven Index declined 6.38 per cent in September to finish 9.22 per cent down in 2008. The Distressed Index declined by 3.85 per cent for the month and its loss for the year extended to 10.31 per cent as the spread on the Merrill Lynch High Yield Index widened sharply during the month from 836 to 1096 basis points, a level not seen since 2002.

The Merger Arbitrage Index declined by 1.77 per cent but remains up a bare 0.71 per cent for the year, as short selling restrictions handicapped managers ability to put on trades. Merger arbitrage spreads have pushed out to very attractive levels with many deals now offering annualised returns of more than 20 per cent, double the level of a few months ago.

The Convertible Arbitrage Index plummeted 11.25 per cent in September, its worst month in history, accounting for most of the 13.40 per cent decline this year. Convertible arbitrage portfolios were under severe negative pressure due to the SEC's ban on short selling of financial stocks and indiscriminate selling due to liquidations. They were also hurt by the actual or near defaults of Lehman Brothers, Fannie Mae, AIG, Washington Mutual and Wachovia, all of whom had tapped the convertible market for capital.

'Many macro managers are betting on lower interest rates in Europe,' Gradante says. 'Currently, Europe has an inverted yield curve while credit spreads are widening. This should help force Europe to lower short-term rates and steepen their yield curve. It will also help the credit markets.'

The Global/Macro Index dropped 5.93 per cent in September and is down 12.74 per cent after three quarters, while international equities continued to decline sharply. The MSCI EAFE Index fell 14.71 per cent during the month and 31.07 per cent so far this year as global markets faced deleveraging and a flight to quality.

International long/short equity funds fared even worse than US funds, as the International Index declined 8.00 per cent, for a 15.76 per cent year to date fall. Weakness was broad-based, but especially painful in emerging markets such as Russia and Brazil.

The Macro Index declined 1.73 per cent, just falling into negative territory (0.16 per cent) for the year. Managers continued to suffer as commodities were sold off, with the Reuters/Jefferies CRB index slumping 43 per cent from its peak in early July.

However, macro managers were able to generate profits as investors poured into gold amid concerns of a global recession. 'Many macro managers have put on a global recession trade,' Gradante says. 'They are long duration bonds while short equities and credit.'

The Hennessee Hedge Fund Indices are calculated from performance data reported to the Hennessee Group by a diversified group of more than 1,000 hedge funds. The Hennessee Hedge Fund Index is an equally-weighted net of fees and unaudited average of the funds in the indices, derived from the group's database of more than 3,500 hedge funds.