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“May was a tough month for risk assets. European worries returned with vengeance resulting in a flight to quality and ‘risk off’ trading. Despite conservative positioning, hedge funds posted their worst monthly loss since September 2011, falling -2%,” commented Charles Gradante, Managing Principal of Hennessee Group. “Many managers are frustrated that they did not ‘sell in May and go away’. May turned out to be a repeat of the previous two Mays [2011 and 2010] due to renewed worries over a financial crisis in Europe, a hard landing in China, and an economic slowdown in the U.S.”

“While many managers anticipated a ‘risk off’ period, they still incurred losses due to a modest net long exposure. Hedge funds were able to protect capital relative to equity markets by being down only one-third the broad market. ” said Lee Hennessee, Managing Principal of Hennessee Group. “With the outperformance in May, hedge funds were able to narrow the gap on year to date performance. For the year, hedge funds are up more than +2% and have displayed significantly less volatility than the broad markets. Managers continue to be conservatively positioned with a cautious outlook for the short term.”

Equity long/short managers posted their worst monthly loss since September 2011, as the Hennessee Long/Short Equity Index declined -1.89% (+2.27% YTD). With earnings season over, equity markets were driven by macro news, poor employment data, and a somewhat disappointing result for the Facebook IPO. Weakness was broad based with the worst performing sectors being energy (-10.62%), financials (-9.32%), materials (-7.99%) and technology (-7.85%). Global equity markets also declined sharply in May as European sovereign debt and bank liquidity concerns resulted in a sharp increase in investor risk aversion. While hedge funds were conservatively positioned at the beginning of May, managers still suffered losses due to a modest net long exposure. The best performing managers were positioned more conservatively with net short exposure or low net long exposure. As concerns about Europe began to flare, managers aggressively reduced risked. Managers remain conservatively positioned as they are cautious about the short term. In addition to the concerns about Europe, which has not fixed its structural problems, managers are concerned about the political situation in the U.S. and the impending “fiscal cliff”. Managers expect continued volatility throughout the year and expect performance to be driven by “alpha generation” related to individual investment opportunities and themes rather than “beta exposure”.

“As May was another ‘risk-off’ month, risk assets, such as equities and commodities, registered double digit losses, while safe-haven assets, such as the U.S. dollar, U.S. Treasury bonds, and German bunds, soared,” commented Charles Gradante. “One of the challenges for long/short equity hedge fund managers is that during a ‘risk-off’ period there are insufficient counterparties to trade against. Stock markets have experienced low volume, which makes markets more volatile. Lastly, markets are reacting to political and macro events, rather than fundamentals, making this a challenging investment environment for stock pickers.”

The Hennessee Arbitrage/Event Driven Index declined -1.09% (+3.47% YTD) in May. The Barclays Aggregate Bond Index increased +0.90% (+2.33% YTD) as bonds were mixed. Treasuries experienced a significant rally as investor shifted into safe havens. The yield on the 10 Year U.S. Treasury declined 36 basis points from 1.95% to 1.59%, the lowest level in 60 years. High yield credit declined as spreads widened, which was exacerbated by the tightening of Treasury yields. The spread of the BofA Merrill Lynch High Yield Master Index widened 92 basis points from 6.04% to 6.96% as the high yield market had net outflows of over $1.5 billion, the first monthly outflow in over six months. With junk bonds yielding over +8%, several managers are becoming increasingly bullish on the opportunity set as fundamentals remain attractive. The Hennessee Distressed Index fell -1.58% in May (+3.82% YTD). The traditionally net long distressed portfolios experienced losses as the equity markets declined sharply. The flight to quality resulted in losses for several core distressed positions in May. The Hennessee Merger Arbitrage Index decreased -0.24% in May (+2.55% YTD). Managers posted small losses as deal spreads widened amid heighted volatility. While deal flow remains below historical averages, managers remain constructive as they are able to identify good investment opportunities, including Viterra & Glencore and Kinder Morgan & El Paso. The Hennessee Convertible Arbitrage Index declined -0.44% (+3.98% YTD). Convertible markets cheapened along with other risk assets, and Europe again underperformed the U.S. Losses were driven by a widening of credit spreads, which were partially offset by short equity exposure, volatility and interest rates.

“Taking their most bearish stance since the end of December, macro hedge funds significantly reduced exposure in commodities markets during the final week of May. Managers reported surpluses in excess of demand in most commodities,” commented Charles Gradante. “During the second half of the month, gold and silver were the only pockets of strength, as investors sought safety amid increasing concern over the global economy and expectations that the Federal Reserve will soon take further steps to stimulate the struggling U.S. economy.”

The Hennessee Global/Macro Index declined -3.37% (+0.49% YTD) in May, driven largely by losses in global markets. Global equities experienced significant losses, as the MSCI All-Country World Index fell -8.99% in May (-0.42% YTD). Weakness was broad based, with the Stoxx Europe 600 losing -5.8%, its worst month since August 2011, and the MSCI Asia Pacific Index falling -9.8%, its worst month since October 2008. International hedge fund managers posted losses, as the Hennessee International Index fell -2.79% (+2.29% YTD). Emerging market experienced sharper declines amid the flight to quality, with the MSCI Emerging Markets Index falling -11.67% (-1.10% YTD). Hedge fund managers experienced losses in both equities and currencies, as the Hennessee Emerging Market Index declined -7.44% (-2.91% YTD). Macro managers were down modestly in May, as the Hennessee Macro Index decline -0.54% (+0.24% YTD). Managers experienced gains in currencies and fixed income, while suffering losses in equities and commodities. Yields in safe haven countries, including the U.S., Germany and Switzerland fell to historical lows. On the short side, the Spanish 10 Year bond yield rose to 6.7%, the most since November 2011, resulting in the bonds declining -4.9%. Greek bonds lost -41% after the May election failed. The flow into U.S. and Swiss debt drove strong currency gains against the Euro. The dollar strengthened relative to all currencies except the Japanese Yen, resulting in the largest rise of the U.S. Dollar Index since September 2011. Managers continued to profit from the weakening of the euro, which declined -6.5% and remains a key theme for macro managers. Physical commodities experienced a major correction, driven lower due to dollar strengthening and declining risk appetites. The Dow Jones-UBS Commodity Index was down -9.14% (-8.74% YTD) for the month of May. Grains sold off following the bearish USDA report, while energy and metals dropped sharply due to concerns about a slowdown in the economic recovery of the EU and U.S. Soft Chinese data and political uncertainty in Europe also pressured the crude oil market as West Texas Crude Oil declined -17.79%. Despite historical safe haven status, gold declined in May, resulting in its 4th consecutive monthly loss.

(press release)

Hennessee Group LLC is a Registered Investment Adviser that consults direct investors in hedge funds on asset allocation, manager selection, and ongoing monitoring of hedge fund managers. Hennessee Group LLC is not a tracker of hedge funds. www.hennesseegroup.com

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