Drop in risk appetite curbs hedge fund returns in December

Date: Wednesday, January 11, 2006
Author: James Langton - www.investmentexecutive.com

S&P Hedge Fund Index rose 2.28% in 2005

Wednesday, January 11, 2006

By James Langton

Hedge fund returns, as measured by the Standard & Poor’s Hedge Fund Index, gained a paltry 0.26% in December as a widespread reduction in risk appetite drove performance down during the month.

According to Standard & Poor’s senior hedge fund specialist, Justin Dew, hedge fund performance during December was dominated by three main occurrences: a strong equity market rally in many Asian markets (notably Japan), a correlated decline in the U.S. dollar versus the yen, and a temporary inversion of the yield curve.

For calendar year 2005, the index rose 2.28%. The S&P Equity Long/Short Index was the best performing sub-index during the year, gaining 9.24%.

The S&P Event-Driven Index gained 0.48% in December, as two of its three underlying strategies ended the month in positive territory. The Special Situations sector performed well during December with strong credit enabling a few key transactions to be realized and making future deals more likely. Merger Arbitrage managers also performed quite well, as a number of deals closed during the month, it notes.

The S&P Directional/Tactical Index lost 0.02% in December, as losses in the Managed Futures sector were only partially offset by gains in the Equity Long/Short sector - a result of long Japanese stock positions, S&P said.

“Strong corporate balance sheets and a sizeable shift on the part of Japanese retail investors from riskless investment assets to domestic equity investments, led the Nikkei higher during the month,” it said. “Global institutional investors continue to allocate massive amounts of capital to the Japanese market causing some Equity Long/Short managers to take pause. Many see this economic upswing as a more extended phenomenon than what has occurred in that region during the past few decades.”

The Macro sector saw gains during December, as some managers continue to believe that there is a substantial likelihood of a near-term recession in the US, S&P added. “As a result, these managers were short the U.S. equity market relative to Asia, yielding solid gains as the Nikkei performed strongly and U.S. markets lagged.”

“In the Managed Futures sector, losses were incurred as a long-standing dollar rally reversed course, particularly versus the Japanese yen and New Zealand dollar. In addition, the yield curve flattened and then inverted briefly during the month, causing short positions in U.S. interest rates to be unprofitable as prices rose and rates fell on the long end of the curve,” it noted.

Crude oil prices were volatile in December causing small losses for many managers, S&P suggested.

The S&P Arbitrage Index gained 0.32% during December led higher by the performance of all three of its underlying strategies, particularly Equity Market Neutral, it noted. “Value models performed well as some traditionally growth-oriented stocks began to look attractive from a value perspective. Higher volatility early in December helped returns as well, though it declined as the holidays and the end of the year drew near,” it said. “In the Convertible Arbitrage sector, small gains emerged from positions in Japanese companies as that market continued its upward trend.”

“Fixed Income Arbitrage managers witnessed mostly flat returns for the month, as a number of them had trades that suffered temporarily when the yield curve inverted,” it said.