HFN Industry Report: May 2011

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HFN Industry Overview: May 2011

On June 21, 2011 with 3,255 hedge fund products reporting, the HFN Hedge Fund Aggregate Index was -1.06% in May and +1.62% YTD 2011 while the S&P 500 Total Return Index (S&P) was -1.13% during the month and +7.82% YTD.

Hedge Fund Industry May Highlights:

•Total industry assets fell an estimated 0.79% to $2.586 trillion in May. Performance accounted for the majority of the asset decrease and net investor allocations were positive for the eleventh consecutive month.
•Many performance drivers in April reversed in May with losses manifest in CTA/managed futures strategies along with energy and technology equity focused funds.
•Credit strategies generally outperformed the rest of the industry, led again by mortgage funds, but gains were also available in certain EM interest rate markets and short European sovereign debt.
•Japan focused funds were down for the third straight month and have lost an average of nearly 5% since the earthquake in March.

The sharp turnaround of the U.S. dollar and the slide in commodity prices were the most evident indicators of a global reduction of exposure to risk assets during the month. Despite the aggregate equity market slide there were pockets of strong returns for hedge funds in the healthcare sector as well as positive performance, albeit slight, for small/micro cap related strategies. Mortgage funds continued to produce positive returns and along with healthcare funds are the only strategy/sector groups to have outperformed the S&P in 2011.

HFN developed the Outlier ratio to determine which sectors are producing returns outside of their normal ranges. In May, it was tech sector, CTA/managed futures and global macro strategies producing abnormally negative aggregate returns.

HFN Regional Benchmarks
Emerging market equities related returns, primarily Russia and India focused strategies, were the largest drag on aggregate EM returns in May. While all emerging market regional exposure produced negative average returns, EM debt strategies were positive for the month. The HFN Emerging Markets Index is barely positive for the year, +0.12%, its lowest level through the first five months of a year since 2008 and second lowest since the Russian financial crisis of 1998.

Australia focused funds declined more than any other developed market in May, falling -2.28% during the month. The group appeared to have ridden the rising commodity price wave through late 2010, but suffered during the sell off in May. The group has outperformed the ASX Index, even in months when the index has risen, but losses in May mirrored the ASX decline.

Monthly Asset Flow Estimates
•Total estimated hedge fund assets at the end of May 2011 were $2.586 trillion, a decrease of 0.79%, or $20.5 billion from April.
•Performance accounted for a decrease of $31.9 billion and investors accounted for a net inflow of $11.4 billion.
•The core rate of growth (% asset change due to investor allocations/redemptions) was 0.44%, a decrease from April and only slightly above the prior twelve month average.
•Total hedge fund AUM is now 14% below the all-time high set in Q2 2008.

Net investor flow information continues to indicate strong interest for investing directly into hedge funds, a trend which has persisted for several months. Despite the declining core rate of growth, May inflows showed the eleventh straight month of net allocations. The monthly total asset decline was only the fourth since April 2009, the last month of massive redemptions outpacing inflows following the crisis.

Sub-Sector Specific Flows
•Investors appear to believe there is profitability investing in Japanese markets. Net investor flows into Japan focused hedge funds have been above the industry average in the last two months.
•Commodity focused funds led inflows by investment market in May followed by four classifications of debt. Flows into mortgage, convertibles, sovereign and corporate bond funds outpaced equity fund flows.
•Funds investing primarily in European markets have had notable swings in investor interest. In April inflows jumped, but in May more money left than was allocated, which had been the trend for several months prior to April.
•Money continued to flow into techonology sector funds, despite the aggregate outsized losses during the month. Healthcare strategies also saw a blip of positive money flows.

Performance Review
Fixed Income (FI) Strategies
•The average return of all fixed income focused strategies was +0.43% in May and +3.64% year-to-date.
•Mortgage funds performed best in May, +1.52% while distressed strategies posted slight declines, -0.23%.
•Fixed income fund assets rose 1.17% in May to an estimated $693.1 billion. Investors added net $5.1 billion during the month.

Equity (EQ) Strategies
•The average return of all equity focused strategies was -0.84% in May and +1.15% YTD.
•Funds investing in healthcare sector equities had the best returns, +1.54%, followed by those investing in small/micro cap issues, +0.29%. Energy sector funds had the most difficult month, -2.43%.
•Equity fund assets fell an estimated 0.71% to $852.5 billion in May. Investors allocated a net $1.9 billion; a decline from April and below the prior twelve month average.

Commodity and Foreign Exchange (FX) Related Strategies
•Broad natural resource commodity strategies were -3.28% in May and -0.16% YTD.
•Funds investing in FX markets gave back most of April’s gains, -2.45% and are now -1.01% for the year.
•Only agriculture funds had aggregate gains in May, +1.51% and funds investing in metals markets fell most, -3.53%.

Summary Analysis
While money flows into hedge funds have continued at an above average pace, the influx of capital may be a vote to the lack of confidence in direct investment in traditional markets. The vast majority of equity markets are in negative territory in June, the Greek debt crisis has European credit markets sitting at a point of flux and commodity prices are mixed with energy prices continuing their fall. These factors point to another difficult month for aggregate hedge fund returns, however it may be a second straight month when the industry outperforms broad equity markets.

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