Hedge Funds Struggle To Keep Pace With Equity Markets

Oct 8 2009 | 9:45am ET

Hedge fund struggled to keep pace with equity markets in September, with the Hennessee Hedge Fund Index gaining 3.18% during the month (20.89% YTD).

At the same time, the S&P 500 increased 3.57% (17.03% YTD), the Dow Jones Industrial Average increased 2.27% (10.66% YTD), the NASDAQ Composite Index advanced 5.64% (34.59% YTD), and the Barclays Aggregate Bond Index advanced 1.05% (5.72% YTD). 

“Hedge fund managers we talk to are concerned that the markets are rallying while the real economy is shrinking,” said Charles Gradante, co-founder of hedge fund advisory the Hennessee Group.  “Liquidity is driving this market, and that is likely to continue with more than $3 trillion on the sidelines.  However, liquidity driven markets eventually dry up.  Hopefully, credit expansion and GDP growth arrive to support the market in 2010.”

“Hedge funds experienced a good month in September, slightly lagging equity markets,” said Lee Hennessee, managing principal of Hennessee Group.  “Managers were able to generate gains without significant market exposure and benefited from good stock selection.  Managers remain cautious as valuations appear high, and prices are being driven by momentum.  Managers have increased gross exposures to normalized levels.”

The Hennessee Long/Short Equity Index gained 3.13% in September (18.75% YTD).

According to Gradante, as the equity markets continue to show strength and momentum, hedge funds have taken on additional directional risk in order to participate in the ongoing equity market rally. That said, they remain cautious and aware the market could turn sharply to the downside given current valuations and the apparent disconnect between technical indicators and fundamentals. 

“Little of the bailout money given to banks seems to have been passed on to businesses or consumers. It must have gone somewhere, and it is possible that is has gone to the proprietary desks of the banks, which are putting it to work in the markets,” said Gradante. “That could lead to a potential problem if the public and institutions do not join the rally, and the banks eventually have to sell equities into a vacuum.”

The Hennessee Arbitrage/Event Driven Index gained 3.04% in September (+23.35% YTD).  Positive contributions came from credit, convertible arbitrage, distressed, merger arbitrage and other strategies. 

The Hennessee Distressed Index advanced 3.92% in September (+28.30% YTD).  Managers benefitted from tightening spreads as well as several event specific catalysts. 

The Hennessee Convertible Arbitrage Index advanced 3.43% (39.29% YTD).  Spreads and secondary market richening were positive contributors to the strategy. 

The Hennessee Merger Arbitrage Index advanced 0.48% in September (6.65% YTD). Mergers and acquisition activity continued with Xerox’s planned purchase of Affiliated Computer Services and Walt Disney’s acquisition of Marvel Entertainment. Managers expect M&A activity to continue, but remain underinvested in merger arbitrage as they feel that there are more attractive opportunity sets currently elsewhere.

The Hennessee Global/Macro Index advanced 3.48% in September (22.05% YTD). Global equities rallied as the MSCI EAFE Index advanced 3.59% (25.49% YTD), with strong performance across most emerging and developed markets, with the exception of Japan.  

The Hennessee International Index increased 3.67% (18.76% YTD).  Emerging markets posted strong performance.  Managers continue to favor the emerging markets as they are likely to post positive GDP growth in 2009 and drive global growth for the next several years.

The Hennessee Macro Index advanced 3.35% in September (12.76% YTD).  Macro managers posted their best month since May as they profited from long positions in precious metals, short the dollar, and long emerging markets. Managers profited long sugar, which is up 80% year to date, as weather conditions in India and South America have diminished supply. 

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