Hedge funds outperform since 2007 peak

Date: Wednesday, December 15, 2010
Author: Emily Perryman, HedgeWeek

Since the equity markets reached a high in October of 2007, there has been a double digit correction followed by a sharp double digit rally, which has made for a very challenging investment environment.

While most broad based equity averages remain well off their highs reached in late 2007, the average hedge fund has recently exceeded its high-water mark and has drastically outperformed its traditional counterparts. 

“The Hennessee Group believes a key driver of this outperformance by hedge funds has been their ability to successfully navigate through these highly volatile and uncertain market environments by adjusting their equity market exposures,” says Charles Gradante, managing principal of Hennessee Group. “Specifically, hedge funds protected investor capital during the severe market correction that commenced in late 2007 by reducing net portfolio exposures and also participated in a good portion of the recent equity market rally by once again adding risk exposure following the financial crisis.” 

For the three year period ended October 2010, the Hennessee Long/Short Equity Index is up 6.10 per cent relative to the S&P 500 Index which is off -22.49 per cent and the Dow Jones Industrial Average which is off -19.99 per cent. 

In a prior research paper, the Hennessee Group estimated that the average net exposure of long/short equity hedge funds decreased by 16 per cent, from 52 per cent at the end of the second quarter of 2007 to 36 per cent in the second quarter of 2008. This reduction in risk exposure allowed the Hennessee Long/Short Equity Index to outperform by a wide margin during the equity market sell-off. 

According to recent Hennessee Group research, hedge funds gradually increased equity market exposure to participate in the market rally that commenced in early 2009. Hennessee Group estimates that long/short equity hedge funds increased their net exposure by an average of 22 per cent, from a low of 34 per cent in the fourth quarter of 2008 to 56 per cent in the first quarter of 2010. In addition, hedge funds increased their absolute gross exposures by an average of 73 per cent over the same time period, from a low of 106 per cent to a high of 179 per cent.

“While hedge funds have reduced exposures again in recent months as the sovereign debt crisis and other macro issues have overshadowed the markets, they remain elevated relative to historical levels and we believe managers will continue to maintain them as the global economy continues to recover and the equity markets further stabilise,” says Gradante. “That said, we believe they will remain cautious as there a number of headwinds that continue to trouble managers. We also expect security selection to be more of an alpha generator going forward as opposed to the exposure adjustment we have witnessed in recent years, particularly as fundamentals begin to matter and we see more dispersion between sectors and stocks.”