Hennessee Group: May Miserable, But Hedge Fund Outperformed Markets

Jun 7 2010 | 9:33am ET

Another hedge fund index is showing what most of us already know—May was a dismal month for the asset class. The Hennessee Hedge Fund Index declined -2.99% in May (+1.57% YTD), while the S&P 500 decreased -8.20% (-2.30% YTD), the Dow Jones Industrial Average declined -7.92% (-2.79%), and the NASDAQ Composite Index fell -8.29% (-0.53% YTD).  Bonds advanced, with the Barclays Aggregate Bond Index increasing +0.84% (+3.74% YTD).
“May was the worst month of the year for hedge funds and the worst monthly drawdown since October 2008.  However, hedge fund managers avoided significant losses and outperformed traditional benchmarks on a relative basis due to conservative exposures, hedging and short positions,” said Charles Gradante, co-founder of hedge fund advisory the Hennessee Group.  “In May, we saw investors significantly de-risk portfolios as volatility increased.  Given the negative headwinds that exist and potential global crises, hedge funds continue to operate with low gross exposure levels as they navigate an increasingly challenging investment environment.”

“Hedge funds’ defensive positioning prior to May helped limit losses and provided downside protection,” said Lee Hennessee, managing principal of Hennessee Group. “Downside protection is the primary benefit of the hedge fund asset class."

The Hennessee Long/Short Equity Index declined -2.81% in May (+1.66% YTD).  According to the advisory firm, the equity market “flash crash”, the downgrade of European debt ratings, the Gulf oil spill, and the escalating tensions in Korea, spooked investors and triggered a flight to quality, namely U.S. Treasuries. 

But while hedge funds struggled to generate positive returns for investors given the broad based sell-off during the month, they still managed to outperform the broader indices on relative basis by a significant margin.  Managers who were quick to trim exposures at the first sign of volatility fared better, with some funds able to squeeze out modest positive gains. In light of the ongoing macro issues and heightened volatility, hedge funds continue to reduce risk and remain cautious.

The Hennessee Arbitrage/Event Driven Index declined -2.62% in May (+3.71% YTD).  As the equity and credit markets declined in May, arbitrage strategies also fell, brought down by event driven, distressed, credit and convertible arbitrage strategies.  Credit spreads widened due to concerns about the European government’s sovereign debt issues, with the spread on the Merrill Lynch High Yield Index widening from 561 basis points to 598 basis points during the month, after hitting a high of 724 basis points mid-month. The Merrill Lynch High Yield Master II Index fell -3.52% (+3.39% YTD). 

The Hennessee Distressed Index declined -4.87% in May (+4.85% YTD).  Distressed funds suffered losses due to declines in the equity and credit markets and the overall flight to quality.  Due to their traditional net long bias, distressed funds typically experience losses in a downturn if there is a lack of specific catalysts.  Despite the downturn in May, Hennessee says managers are still seeing ample long and short opportunities in distressed situations and dislocated assets. Managers are active in acquiring assets from banks and other lenders that continue to sell off assets in order to clean up balance sheets. 

The Hennessee Merger Arbitrage Index also declined, -1.04% in May (+1.29% YTD), as did the Hennessee Convertible Arbitrage Index -3.00% (+2.08% YTD). 

“I cannot remember when there have been so many potential ‘global crises’ happening at the same time,” said Gradante. “We have the oil spill in the Gulf of Mexico, the downgrades of the European PIIGS, altercations in the Middle East and Korean Peninsula, and concerns about Chinese monetary policy.  In addition, domestically, we are facing greater uncertainty regarding regulation of markets, massive U.S. government debt, significantly higher taxes and the withdrawal of Federal stimulus.  There are many things keeping hedge fund managers awake at night, and as a result, managers are operating with lower gross exposure levels.”
The Hennessee Global/Macro Index fell -3.50% in May (-0.65% YTD); The Hennessee International Index fell -4.02% (+0.38% YTD); And the Hennessee Macro Index fell -0.79% for the month (+1.22% YTD).  

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