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Charles Gradante

"Renewed optimism about the U.S. economic recovery, Europe's ability to address its debt problems, and China's ability to avoid a hard landing resulted in a remarkable 'risk on' phase," commented Charles Gradante, Co-Founder of Hennessee Group. "Hedge funds posted their best monthly gain so far this year, driven by the rebound in risk assets."

"Performance indicates that hedge funds were underexposed to the markets. Many were conservatively positioned with low gross and net exposures, and as a result, they did not fully participate in the market rally." commented Lee Hennessee, Managing Principal of Hennessee Group. "In addition, massive short covering resulted in negative alpha generation and detracted from performance."

The Hennessee Long/Short Equity Index advanced +3.14% (-2.53% YTD) in October. Managers benefited from the strong equity rally as the S&P 500 gained +10.77%, essentially erasing the year's entire loss (-0.35% YTD). All sectors were positive in October. The best performing sectors were energy (+16.95%) and materials (+17.90%), while telecommunication services (+1.76%) and utilizes (+3.52%) were the worst performing. Small caps also performed well as the Russell 2000 gained +15.04% (-5.43% YTD). Hedge fund managers were conservatively positioned with gross and net exposures at the lower end of historical ranges and with significant cash balances. The best performing managers increased exposures intra month as the equity markets rallied.

U.S. domestic earnings dominated the month, and, according to reports, more than two thirds of the companies beat their estimates. While hedge fund managers typically outperform during earnings season as they are able to pick winners and losers, this period was challenging as correlations among securities remained extremely high. In addition, the run up in risk assets was also largely due to short covering. The most shorted stocks outperformed the least shorted stock during the rally, which detracted from performance and resulted in negative alpha generation in portfolios.

"It has been an extremely challenging investment environment. We have seen managers get 'whipsawed' due to headline risks, especially related to the Eurozone sovereign debt crisis," commented Charles Gradante. "Looking forward, things should remain volatile. Europe needs to decide on upcoming Greek debt details and austerity programs, and, in the U.S., the congressional Super Committee's deadline for $1.2 trillion in cuts and taxes is looming in November." The Hennessee Arbitrage/Event Driven Index rallied in October, increasing +1.85% (-1.68% YTD) as risk assets rallied and spreads tightened. The Barclays Aggregate Bond Index advanced +0.11% (+6.79% YTD) as bonds were mixed. Treasuries declined with the S&P/BG Cantor 7-10 Year Treasury Bond Index falling -1.31% (+12.73%) during the month, as the 10-year Treasury yield increased 25 basis points to 2.17% from 1.92%. The Barclays High Yield Credit Bond Index increased +5.99% (+4.52% YTD).

While new issue activity continues to be limited relative to earlier in the year, there were some positive signs as some issuers were able to tap the capital markets. The Hennessee Distressed Index increased +2.75% in October (-2.32% YTD). Distressed portfolios rebounded as the equity markets rallied. However, distressed and illiquid names generally lagged more liquid names during the rally. In addition, hedges, which had increased during the turmoil in September, detracted from performance. The Hennessee Merger Arbitrage Index advanced +1.47% in October (-0.13% YTD). Managers benefited from the equity market rally and spread tightening. There was a healthy flow of new deals, and managers are actively adding new merger arbitrage situations to their portfolios, including Goodrich and Synthes.

While deal spreads have narrowed, they remain attractive. The Hennessee Convertible Arbitrage Index returned +1.15% (-1.06% YTD) in October. During the month, convertible bond valuations generally richened in most global regions. The rally in the equities and tightening of credit spreads led to convertibles being better bid. The volatility index VIX eased to 30 from its September month-end level of 43. "Some managers have expressed concern that the assertion of a German led fiscal integration in the euro zone would make it increasingly unattractive for all the countries that joined to stay in the single currency," commented Charles Gradante. "Portugal, Ireland, Finland and Greece could pull out of the Euro rather than have to operate under a single euro zone treasury."

The Hennessee Global/Macro Index increased +1.47% in September (-5.29% YTD). The MSCI All-Country World Index of global stocks jumped +10.62% in October (-6.11% YTD), its best month since April 2009, after Germany and France pledged to support European banks and increase the rescue fund. Strength was broad based as all developed markets were positive except Greece.

International hedge fund managers were positive, but lagged the benchmark due to cautious positioning, as the Hennessee International Index advanced +1.84% (-4.72% YTD). Emerging markets advanced +12.23% in October, which was their best monthly performance since May 2009. Russia gained +16.72% (-13.91% YTD), Brazil added +18.34% (-16.67% YTD), and China increased +16.65% (-15.30% YTD).

Hedge fund managers were conservatively positioned with low beta exposure going into October, and underperformed on a relative basis, as the Hennessee Emerging Markets Index was up +2.94% (-8.67% YTD). The Hennessee Macro Index was down -0.56% in October (-0.56% YTD). Macro managers again displayed wide performance dispersion. Managers positioned bullish on risk assets experienced gains, while managers bearish on risk assets suffered losses as investors' excitement over the most recent plan to address the European sovereign debt crisis drove strong rallies in risk assets.

The S&P Goldman Sachs Commodity Index retraced much of its September losses, advancing +9.75% in October (+0.46% YTD). The gains were led by strong performance of oil prices and supported by a -3.04% decline in the U.S. Dollar Index. Emerging and commodity-linked currencies rebounded after a sharp selloff in September. Gold also reversed some of its recent losses, returning to almost $1,750 an ounce.

(press release)

For a more in depth monthly review of the economy, capital markets, and hedge fund performance and strategies, the Hennessee Group offers the monthly Hennessee Hedge Fund Review (www.hennesseegroup.com/hhfr/)...Full performance table:Source

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