Opalesque Industry Update: Hennessee Group LLC, an adviser to hedge fund investors, announced today that the Hennessee Hedge Fund Index increased +0.47% in July (+2.78% YTD), while the S&P 500 gained +1.26% (+9.68% YTD), the Dow Jones Industrial Average advanced +1.00% (+6.48% YTD), and the NASDAQ Composite Index increased +0.15% (+12.83%). Bonds were also up, as the Barclays Aggregate Bond Index increased +1.38% (+3.78% YTD) and the Barclays High Yield Credit Bond Index increased +1.90% (+9.30% YTD).|
“July was another choppy month for equity markets and risk assets in general. Financial market volatility continued in July due to slowing economic growth in the U.S. and China and concerns about the European sovereign debt and banking crisis. ‘Risk off’ assets performed well as yields on U.S. and German government bonds declined to record lows. ‘Risk on’ assets were also positive as global equity markets generally posted gains for the month,” commented Charles Gradante, Managing Principal of Hennessee Group. “Hedge funds were conservatively positioned as the European situation remained precarious, and underperformed other risk assets.”
“Managers report that shorting has been challenging. Many maintain low net exposure because they are cautious about overall market direction, but would like to have higher gross exposure,” commented Charles Gradante. “Managers state that it has been challenging to grow the short portfolio as many shorts have declined in value, which reduces short exposure. In addition, it has been difficult to find and size new ideas as the market declines. Some managers are utilizing ETFs, which detracted from performance in the sharp late month rally.”
Equity long/short managers were essentially flat in July, as the Hennessee Long/Short Equity Index advanced +0.05% (+2.63% YTD). Equity markets were volatile again punctuated by a late month “risk on” rally as money moved out of treasuries into equities, sparking a +2% rally in the broad averages. The best performing sectors were telecommunications (+5.48%), energy (+4.06%), and consumer staples (+2.61%). The worst performing sectors were materials (-1.33%), consumer discretionary (-0.34%) and financials (+0.03%). Hedge funds performed well during the first couple weeks of July when global equity markets declined amid concerns about Europe. However, hedge funds underperformed as markets rallied on the hope that the European debt problems would be fixed. Many managers were cautious about increasing exposures into the “risk on” move due to fears that relief rally would be brief and risk of getting whipsawed would be high. While July is typically a strong month for long/short equity managers due to second quarter earnings reports, many managers struggled to generate alpha. While long portfolios performed well, short portfolios detracted from performance. Despite markets climbing higher, managers remain cautiously positioned with low net exposures. Managers remain worried about slowing growth in the U.S. and China as well as unresolved issues in Europe. In addition, investors are concerned about the November elections and the year-end “fiscal cliff” of tax cuts and economic stimulus that could drive the U.S. economy into recession.
“Stocks took a leap of faith that the Fed is making plans to shore up the economy and financial markets. The market rose +3% after the GDP was reported at 1.5%.” said Lee Hennessee, Managing Principal of Hennessee Group. “Hedge funds continue to be frustrated by a challenging investment environment. Managers remain steadfast, refusing to chase brief relief rallies and risk being whipsawed. Managers are waiting for markets to fit their strategy and for macro dominance to abate before aggressively deploying risk.”
The Hennessee Arbitrage/Event Driven Index advanced +0.70% (+4.17% YTD) in July. Like equity markets, credit markets were volatile, but posted gains by month end. Treasury yields ended the month lower, as the yield on the 10 Year U.S. Treasury declined 16 basis points from 1.67% to 1.51%. The Barclays Aggregate Bond Index increased +1.38% (+3.78% YTD) and the Barclays High Yield Credit Bond Index increased +1.90% (+9.30%). The spread of the BofA Merrill Lynch High Yield Master Index tightened 28 basis points from 6.44% to 6.16%. In addition, many managers experienced gains in asset-backed securities (ABS) and especially residential mortgage backed securities (RMBS), which had a strong month as investors continued to reach for better yields. Managers still like the space but state that the easy money has been made. The Hennessee Distressed Index increased +0.91% in July (+4.01% YTD). Distressed managers experienced gains as the markets rallied. Hedges detracted from performance. Some managers experiencing outsized gains from distressed exposure in Europe. The Hennessee Merger Arbitrage Index increased +0.38% in July (+2.54% YTD). Despite the market rally, merger arbitrage managers posted modest gains due to mixed performance across core positions, including CNOOC bid for Nexen. The Hennessee Convertible Arbitrage Index advanced +1.04% (+6.00% YTD). Convertible arbitrage managers were positive as risk markets rallied, yields continued to decline, and credit spreads tightened.
“Managers like high yield bonds as there is no foreseeable reason for the yield curve to steepen with the current economic condition and monetary policy,” commented Charles Gradante. “Managers also state that government bonds are overvalued and they will begin to short them at some point in the future. It will be hard for the Fed to keep U.S. rates down indefinitely. Any good news from here could lead to a reversal. Managers believe that there will be a time when shorting Treasuries and German Bunds is going to be very profitable.”
The Hennessee Global/Macro Index advanced +1.04% (+1.33% YTD) in July, its best month since February. Global equities were volatile, but posted gains. The MSCI All-Country World Index ended the month up +1.25% (+5.51% YTD) on speculation the ECB would buy bonds to help cut borrowing costs and save the euro. The index reversed course several times in July, registering 3% swings on four separate occasions. International hedge fund managers posted gains, as the Hennessee International Index advanced +1.37% (+3.55% YTD). Emerging markets were also positive as the MSCI Emerging Markets Index gained +1.61% (+3.94% YTD). Hedge fund managers posted gains, but underperformed due to conservative exposure levels, as the Hennessee Emerging Market Index advanced +0.93% (-2.07% YTD). Macro managers posted gains in July, as the Hennessee Macro Index advanced +3.10% (+2.83% YTD). Macro managers posted a strong month with profits coming from a several trades, including long commodities, long bonds, long the U.S. dollar, and short the euro. Agricultural commodities had a strong month due to supply concerns caused by the drought in the U.S. Managers generated gains in soybeans, wheat and corn, which all rallied sharply. Oil and natural gas also posted gains. In currencies, the U.S. Dollar gained +2.5% against the Euro, while declining -1.5% against the Yen. Macro managers also had positive contributions from U.S. and German fixed income, which profited from weakening European economic conditions and a downgrade of Chinese growth forecasts by the IMF.