Hennessee: HEDGE FUNDS DECLINE -0.25% IN JULY

Hedge Funds Protect Capital as Markets Decline

Hennessee Group LLC, an adviser to hedge fund investors, announced today that the Hennessee Hedge Fund Index declined -0.25% in July (+1.41% YTD), while the S&P 500 declined -2.15% (+2.75% YTD), the Dow Jones Industrial Average fell -2.18% (+4.89% YTD), and the NASDAQ Composite Index decreased -0.62% (+3.90% YTD). Bonds rallied amid the volatility, as the Barclays Aggregate Bond Index advanced +1.59% (+4.37% YTD) and the Barclays High Yield Credit Bond Index advanced +1.16% (+6.20% YTD).

“With defensive positioning and low exposures, hedge funds were able to protect capital as the equity markets sold off in July amid concerns about economic growth and the political impasse around the U.S. debt ceiling,” commented Charles Gradante, Co-Founder of Hennessee Group. “In July, there was better dispersion and lower correlations among securities as companies started to report Q2 earnings, which allowed managers to generate alpha on long and short portfolios. However, we have seen a spike in correlation and massive de-risking in early August, which will likely prove challenging for hedge funds in the short term.”

“It has been a challenging year with several episodes where hedge funds had the potential to be ‘whipsawed’ by sharp reversals between risk-on and risk off periods,” commented Lee Hennessee, Managing Principal of Hennessee Group. “For the year, hedge funds are modestly positive, underperforming most traditional benchmarks. Hedge funds have been willing to sacrifice upside participation in order to be more cautious and defensively positioned. This will hopefully benefit managers in August as the markets are experiencing a sharp and painful correction in risk assets.”

Despite gains early in the month, the S&P 500 ended July down -2.15% due to the political debate around the U.S. debt issue. The worst performing sectors were industrials (-7.02%) and telecommunication services (-6.67%). The only sectors positive for the month were information technology (+1.57%) and energy (+0.64%). The Hennessee Long/Short Equity Index declined -0.55% (+2.23% YTD) in July, its third consecutive negative month. While macro headlines were largely negative, companies reacted strongly to earnings and reports of forward guidance. According to S&P, over 70% of the index members either posted a gain or doubled the index decline of -2.15%. This significant dispersion was a benefit to stock pickers, allowing managers to generate alpha. In addition, managers are encouraged by the fact that second quarter earnings were strong. While Q3 and Q4 estimates are still expected to be record highs, managers are a bit concerned that expectations are too high. However, despite these positive developments, managers are cautious and have been reducing exposures over in recent months due to the macro headwinds and increased volatility.

“In an effort to reduce risk, investors are piling into government bonds and selling risk assets, such as equities and commodities. This has been the ‘typical’ risk-off trade for the last 18 months,” commented Charles Gradante. “However, investors are not appreciating the real risk in Treasuries. It is really not attractive to buy Treasuries at 2.6% and be repaid in dollars that will be worth significantly less in ten years.”

The Hennessee Arbitrage/Event Driven Index declined modestly in July, falling -0.22% (+1.85% YTD). Fixed income benefited from a flight to quality as investors piled into bonds and yields dropped significantly. U.S. Treasuries experienced significant gains in July. In addition, the U.S. corporate credit markets performed well during July as the S&P/LSTA Leveraged Loan Index gained +0.2% and the Barclays High Yield Credit Bond Index advanced +1.16%. Prices benefited from investor inflows, U.S. Treasury bond performance and improved corporate earnings. The Hennessee Distressed Index decreased -0.91% in July (+3.85% YTD). Some benefited from position specific catalysts, such as an asset sale by Nortel Networks, but in general, portfolios declined as the market sold off and investors reduced risk. The Hennessee Merger Arbitrage Index declined –0.87% in July (+1.84% YTD). Spreads widened and managers experienced losses, specifically in the media sector. The Hennessee Convertible Arbitrage Index returned -0.33% (+2.60% YTD) in July. The U.S. convertible market sold off as the Merrill Lynch CB index cheapened by 70 basis points to 28 basis points cheap in July, a level not seen since October 2009.

“Managers reported that one reason for earnings slowdown in global growth companies is that margins have been shrinking in emerging markets, which are not providing the bottom line growth as originally expected,” commented Charles Gradante. “Competition is greater than anyone expected. The supply from competition outpaces demand putting pressure on margins for all G-7 exporters.”

The Hennessee Global/Macro Index advanced +0.43% in July (-0.94% YTD). Global markets staged a brief rally during the beginning of the month, but retraced to post losses for the month, with the MSCI All-Country World Index falling -1.72% in July (+1.59% YTD). International hedge funds outperformed due to superior stock selection and conservative positioning, as the Hennessee International Index posted a gain, up +1.04% (+1.58% YTD). Emerging markets outperformed their developed counterparts. In July, the MSCI EM Index declined -0.74%, as Latin America was one of the worst performing regions. Hedge fund managers were up modestly, as the Hennessee Emerging Markets Index advanced +0.44% -0.03% YTD), benefiting from positive contributions from Asia, Russia and other emerging markets. The Hennessee Macro Index was positive, rising +0.62% for July (-2.05% YTD). Managers generated gains in fixed income, short the U.S. dollar, and long commodities, including precious metals, oil and agricultural commodities. Every major S&P GSCI commodity sector increased in July. Precious metals were the top performing sectors, up +9.5% on a weaker U.S. dollar and concerns about the global economy. Silver was the best performing commodity in July, up +13.2%. Gold ended the month at a new high, closing at $1,629, as investors sought to avoid paper currency.


* For a more in depth monthly review of the economy, capital markets, and hedge fund performance and strategies, the Hennessee Group offers the monthly Hennessee Hedge Fund Review (www.hennesseegroup.com/hhfr/).