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“Hedge funds protected investors from major losses during January’s sell-off,” A.J. D’Asaro, fund analyst at Morningstar, said. “Poor economic data from the United States, higher interest rates, and a strengthening U.S. dollar following tapering left global stocks with losses, but hedge funds were able to sidestep most of the decline.” Investors fled emerging markets due to concern over a strengthening U.S. dollar, diminishing growth prospects, and political risk. The Morningstar MSCI Emerging Markets Hedge Fund Index was hit particularly hard, with a decline of 1.9% in January. However, hedge funds sidestepped major losses in the unhedged MSCI Emerging Markets Index, which had more exposure to currency declines, and sank 6.5% as a result. The Morningstar MSCI Emerging Markets Hedge Fund Index has fallen 1.5% for the twelve months ended January 2014, while the MSCI Emerging Markets Index has plummeted 10.2%.

U.S. equity-based hedge fund strategies benefited from hedges onequity markets in January and eked out slightly positive returns. The Morningstar MSCI North America Hedge Fund Index increased 0.1% in January, while the S&P 500 Index sank 3.5%. The Morningstar MSCI Small Cap Hedge Fund Index, which represents small-cap long-short equity strategies, rose 0.4% in January, while the Russell 2000 Index fell 2.8%. The Morningstar MSCI North America Hedge Fund Index and the Morningstar MSCI Small Cap Hedge Fund Index have risen 10.9% and 17.2%, respectively,for the twelve months ended January 2014 while the S&P 500 and Russell 2000 Indexes have increased 21.5% and 27.0%, respectively.

Fixed income hedge funds advanced after U.S. tapering was revealed to be milder than expected. The Morningstar MSCI Fixed Income Hedge Fund Index inched up 0.7% in January, underperforming the Barclays US Aggregate Bond Index, which climbed 1.5%. The duration-neutral Morningstar MSCI Fixed Income Arbitrage Hedge Fund Index also rose 0.3%. The Morningstar MSCI Fixed Income Hedge Fund Index and Morningstar MSCI Fixed Income Arbitrage Hedge Fund Index have increased 4.0% and 3.1% for the twelve months ended January 2014, respectively, benefiting from hedged duration risk throughout 2013. In contrast, the unhedged Barclays Global Aggregate TR Index decreased 1.1% in January and has fallen 0.7% for the trailing twelve-month period.

Managed futures hedge fund strategies suffered as positive two-month trends in risk assets reversed sharply. The Morningstar MSCI Directional Trading Hedge Fund Index, which includes both discretionary and systematic futures- based strategies, fell 1.6%, and the Morningstar MSCI Systematic Trading Hedge Fund Index slumped 2.3% in January. For the twelve months ended January 2014, the Morningstar MSCI Directional Trading Hedge Fund Index decreased 0.7%, and the Morningstar MSCI Systematic Trading Hedge Fund Index declined 4.5% as hedge funds struggled with frequent reversals of investor sentiment in 2013.

Arbitrage strategies performed well in January partly due to strong deal flow, which included Liberty Media’s proposed $20 billion acquisition of minorities at Sirius XM Holdings and Suntory’s $14 billion acquisition of Beam. The Morningstar MSCI Arbitrage Hedge Fund Index rose 0.5%, and 4.6% for the trailing twelve-month period. Corporate merger activity continued to pick up as companies rushed to take advantage of low interest-rate financing.

In aggregate, single-strategy hedge funds experienced net outflows of $3.1 billion in December. Multistrategy hedge funds led the losses with outflows of $2.0 billion, followed by systematic futures with outflows of $787 million. Systematic futures hedge funds have bled assets for four straight months, summing to a staggering loss of $10.7 billion for 2013. Event-driven hedge funds received the largest inflows of $294 million in December, followed by long- short debt hedge funds with inflows of $235 million, as investors sought low-risk alternatives to traditional fixed income. For the year, single-strategy hedge funds lost $6.9 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 lost $2.4 billion and $1.4 billion, respectively, in 2013. Funds with no rating raised $7.8 billion in assets in 2013, while rated funds shed $14.7 billion.

Morningstar

Press Release

BM