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Morningstar MSCI Composite AW Hedge Fund Index up +0.9% in December; (+9.2% 2013)

Tuesday, January 28, 2014
Opalesque Industry Update - Morningstar, Inc., a leading provider of independent investment research, today reported preliminary hedge fund performance for December 2013 as well as estimated asset flows through November. The Morningstar MSCI Composite AW Hedge Fund Index, an asset-weighted composite of nearly 1,000 hedge funds in the Morningstar Hedge Fund database, rose 0.9% in December, along with global stock markets. The MSCI World NR global stock index climbed 2.1%, and the Barclays Global Aggregate TR bond index fell 0.6% in part due to rising U.S. and European interest rates in December. The Morningstar MSCI Composite AW Hedge Fund Index increased 9.2% in 2013.

“In December, hedge funds benefitted from a continuation of the prior-month’s trends,” A.J. D’Asaro, fund analyst at Morningstar, said. “Funds that were surprised by rising interest rates in the United States and falling emerging market stocks in November were able to reposition themselves and deliver gains in December.”

Hedge funds concentrated in emerging markets, which lost more than expected last month, regained some of their losses in December. The Morningstar MSCI Emerging Markets Hedge Fund Index rose 0.8% in December, as hedge funds pivoted exposures away from the BRICS and into frontier markets such as the Middle East, which performed much better. Hedge funds strongly outperformed the unhedged MSCI Emerging Markets Index, which had more exposure to Brazil, China, and India—some of the worst-performing countries—and declined 1.5% as a result. The Morningstar MSCI Emerging Markets Hedge Fund Index climbed 3.7% for the year ended December 2013, while the MSCI Emerging Markets Index declined 2.6%.

U.S. equity-based hedge fund strategies profited from a milder Fed tapering than expected and improving economic data in the United States, including GDP growth, non-farm payrolls, and industrial production. The Morningstar MSCI North America Hedge Fund Index increased 1.5% in December as the S&P 500 reached new all-time highs. Similarly, the Morningstar MSCI Small Cap Hedge Fund Index, which represents small-cap long-short equity strategies, rose 1.7% in December, while the Russell 2000 Index climbed 2.0%. The Morningstar MSCI North America Hedge Fund Index and the Morningstar MSCI Small Cap Hedge Fund Index rose 13.6% and 21.0%, respectively, in 2013 while the S&P 500 and Russell 2000 Indexes increased 32.4% and 38.8%, respectively.

Fixed income hedge funds eked out increases despite U.S. tapering and rising interest rates globally. The Morningstar MSCI Fixed Income Hedge Fund Index inched up 0.2% in December, aided in part by investments with higher credit risk. The duration-neutral Morningstar MSCI Fixed Income Arbitrage Hedge Fund Index also rose 0.7%. The Morningstar MSCI Fixed Income Hedge Fund and Morningstar MSCI Fixed Income Arbitrage Hedge Fund indexes increased 3.9% and 3.5% in 2013, respectively, benefiting from hedged duration risk throughout 2013. In contrast, the unhedged Barclays Global Aggregate TR Index decreased 0.6% in December and has fallen 2.6% for the year.

Managed futures hedge fund strategies were buoyed higher as global equities, wheat, natural gas, and several currencies continued strong prior-month trends. The Morningstar MSCI Directional Trading Hedge Fund Index, which includes both discretionary and systematic futures-based strategies, gained 0.9%, and the Morningstar MSCI Systematic Trading Hedge Fund Index rose 1.1% in December. For 2013, the Morningstar MSCI Directional Trading Hedge Fund Index increased 2.7%, but the Morningstar MSCI Systematic Trading Hedge Fund Index was flat as hedge funds struggled with volatility surrounding frequent reversals of investor sentiment during the year.

Unrelated to the broad markets, arbitrage strategies performed well in December. The Morningstar MSCI Arbitrage Hedge Fund Index rose 0.9%, and 5.0% for the year. Throughout 2013 the market embraced acquisitions by bidding up the stock prices of the buyer in M&A deals, encouraging more deals.

In aggregate, single-strategy hedge funds experienced net inflows of $590 million in November. Long-short debt hedge funds received the largest inflow of $692 million, as investors began to seek alternatives to traditional fixed income in a rising rate environment. The systematic futures category led the losses for the third straight month with outflows of $975 million, adding to its growing loss of $9.9 billion for the year through November. Year-to-date through November, single-strategy hedge funds have lost $4.7 billion, with the majority of outflows coming from systematic futures hedge funds. In addition, long-only equity hedge funds and global long-short equity hedge funds have lost $2.3 billion and $1.4 billion, respectively, for the year through November. Funds with no rating have raised $7.2 billion in assets for the year through November, while rated funds have shed $12.0 billion.

December returns for the Morningstar MSCI Hedge Fund Indexes are based on funds that reported as of Jan. 23, 2014. November asset flows are based on funds that reported as of Jan. 14, 2014. Hedge fund investors, managers, consultants, and advisors can access additional information through Morningstar DirectSM, the company’s global research platform for institutions.

Morningstar

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