Hedge fund performance anemic in first half of 2005

By James Langton

Hedge fund returns were essentially flat in the first half of 2005, according to Standard & Poors’ hedge fund index. S&P says that hedge fund managers are taking more risks in search of better returns.

S&P’s hedge fund index gained 0.90% in June, pushing the first half return barely into positive territory, up 0.13%. All three of the S&P HFI’s sub-indices rose during June, with the S&P directional/tactical index gaining 1.62%, the S&P event-driven index adding 0.85%, and the S&P arbitrage index up 0.24%. However, in the first half, only the event-driven sub-index is registering a positive return, up 1.7%. The directional/tactical and arbitrage sub-indicies are down 0.76% and 0.52%, respectively.

With these relatively weak returns, and a stable macro environment, hedge fund managers are taking more risks, S&P says. "Managers have become less risk averse due to a combination of more predictable monetary policy and contained inflation," says Charles Davidson, senior hedge fund specialist at S&P. "This has encouraged greater confidence in asset allocations toward higher yielding risk assets and increased leverage to generate target returns. With the end of quarter redemption cycle behind them, managers are shifting focus from liquidity management to security selection with the objective of finishing the year on a high note."

The gain for the S&P event-driven index came as its three underlying strategies (merger arbitrage, special situations and distressed) all ended the month in positive territory, S&P noted. But the popularity of hedge funds and the corporate credit environment are making it tough to find returns, it suggested. "Several managers noted that their space has become more difficult due to a number of factors, including the reduction in debt issuance as companies develop cash reserves and pay down existing debt. Managers also noted that finding attractively priced securities, when forced to bid against other funds in an environment of cheap funding, is making life more difficult."

It also reported that the S&P managed futures index rose 1.86% in June, "as major profits were made on long positions in the U.S. dollar, bonds, crude oil, equity indices and grains. Metals such as gold and nickel, both of which reversed strong upward trends late in the month, contributed to losses. Copper, however, continued to be profitable as it rose on tight inventories," S&P said. Yet, despite a solid performance in June, the index was still down 8.5% for the first half.