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Hennessee Group LLC, an adviser to hedge fund investors, announced today that the Hennessee Hedge Fund Index declined –3.78% in September (-5.53% YTD), while the S&P 500 declined -7.18% (-10.04% YTD), the Dow Jones Industrial Average decreased -6.03% (-5.74% YTD), and the NASDAQ Composite Index fell -6.36% (-8.96% YTD). Treasury and high quality bonds rallied amid the volatility, as the Barclays Aggregate Bond Index advanced +0.73% (+6.67% YTD), while the Barclays High Yield Credit Bond Index fell -3.27% (-1.38% YTD).
“September was another challenging month for hedge funds, capping one the of the worst performance quarters in history, largely driven by increased European sovereign debt risks and not declining domestic equity fundamentals. In response, managers have significantly reduced gross and net exposures in line with increased volatility, resulting in abnormally high cash levels and low net exposures,” commented Charles Gradante, Co-Founder of Hennessee Group. “Managers are looking for market transparency and stabilization before getting reinvested. Consequently, their reactive cash and net exposures present relative ‘whiplash’ performance risk should there be a sharp equity rally in the fourth quarter.”
“2011 has been a challenging year for hedge funds. There is a lot of concern that 2011 might be another 2008,” commented Lee Hennessee, Managing Principal of Hennessee Group. “At this point, we do not think that is the case. Capital markets remain open, and liquidity is adequate in most markets. Corporate balance sheets are improved, and we are seeing more stock buybacks and insider buying. From a hedge fund perspective, funds are conservatively positioned with low leverage and virtually no margin, greatly reducing any chance of forced selling or liquidations.”
The Hennessee Long/Short Equity Index declined -3.77% (-5.31% YTD) in September, its fifth consecutive negative month.
Managers experienced losses as long portfolios significantly declined in value. Hedge fund managers continued to aggressively bring down gross and net exposures amid the market decline. September was the worst month for the S&P 500 since the loss of -8.20% in May 2010. Utilities were down -0.13%, the best performing sector this month. Materials were the worst performing sector, off -12.59% as commodity prices fell, followed by energy (-12.58%) and financials (-11.56%).
Hedge funds were hurt by the underperformance of small caps, as the Russell 2000 index fell -11.37% for the month (-17.80% YTD). Market correlation, which spiked to a record high of 0.84 in August, remained elevated, resulting in a challenging stock picking environment. Managers remain concerned about global growth prospects as the debt issues in Europe continue as well as deleveraging in the U.S. continues and a hard landing in emerging markets. While managers remain cautious, they are growing more optimistic on investment opportunities once the markets stabilize. Managers are looking for the release of third quarter earnings and more importantly guidance in October to provide insight into the extent of the slowdown and its impact on growth.
“Most sentiment measures are close to March 2009 lows, but not quite there. Financial markets are focused in on the sovereign debt crisis in Europe as the macro issue that must be resolved before volatility and negative sentiment will subside,” commented Charles Gradante. “Hedge funds are going to remain cautious with a lot of ‘dry powder’. Great opportunities in risk assets are created during macro crises, as we saw in 2009, and hedge fund managers are getting ready to capitalize.”
The Hennessee Arbitrage/Event Driven Index declined in September, falling –3.15% (-3.90% YTD) as risk assets declined and spreads widened.
For the month, high-yield bonds declined -3.3%, underperforming safe haven products, such as investment grade bonds (-0.2%) and 10 year Treasuries (+2.8%).
High yield bond and loan spreads widened 108 basis points and 2 basis points to 834 basis points and 795 basis points, respectively, their highest level since September 2009.
The Hennessee Distressed Index decreased -6.31% in September (-7.82% YTD).
Distressed managers continue to suffer losses due to declining equity markets, greater concentration, and reduced liquidity.
Default volume increased in September, as $4.0 billion in high-yield bonds and institutional loans defaulted.
The Hennessee Merger Arbitrage Index declined –2.03% in September (-1.56% YTD).
Merger spreads widened in September.
While M&A volume has slowed in recent months, there have been several attractive deals.
Managers invested in the recently announced Motorola Mobility, Petrohawk and Goodrich deals.
Given the investment environment, managers have become more selective in deal selection, focusing mostly on strategic deals, which are offering annualized spreads in the 8% to 10% range.
Once the European debt issues are resolved, managers expect deal activity to pick up.
The Hennessee Convertible Arbitrage Index returned -2.93% (-2.18% YTD) in September.
Managers report that convertibles performed reasonably well, but cheapen along with other risk assets in September.
Managers are encouraged as they see no signs of “gapping bids” to the downside or forced selling that convertibles faced in 2008.
Owners of convertibles remain diversified with a large number of traditional outright buyers as well as hedge funds with low leverage.
Supply remains constrained with essentially no new issuance over the last two months.
“Managers fear that the current Chinese currency policy is hurting the global recovery. China's currency by all measures is undervalued, which is curtailing the country’s imports,” commented Charles Gradante. “We are in the midst of a global rebalancing, but China is not participating in that rebalancing. China is reluctant to let the Yuan appreciate, as it should, in order increase domestic consumption of imports from developed counties and reduce trade deficits in the U.S. and EU.”
The Hennessee Global/Macro Index declined -4.25% in September (-7.49% YTD). International managers experienced losses as global markets continued to plummet amid concerns about a slowdown in global growth, the European sovereign debt crisis and a potential hard landing in China. Financial markets across the globe declined with the MSCI All-Country World Index falling -8.85% in September (-13.75% YTD), its worst month since October 2008. Europe (-11.11%) was again hit especially hard, while Japan was on the best performing countries, down only -2.07% for the month. International hedge fund managers outperformed, as the Hennessee International Index declined -2.88% (-6.44% YTD). Managers benefited from reduced gross and net exposure levels. Emerging markets underperformed developed markets due increased risk aversion and concerns about Chinese growth. The MSCI EM Index declined -14.78% (-23.53% YTD). Hedge fund managers outperformed on a relative basis, as the Hennessee Emerging Markets Index fell -7.61% (-11.75% YTD). The Hennessee Macro Index was down -1.26% in September (-1.09% YTD). There were several macro themes that made significant moves in September. Managers long the U.S. dollar experienced gains as it rose +6% in September, its biggest monthly increase since October 2008. Managers experienced losses long the Swiss Franc and Japanese Yen, viewed as safe havens, as Switzerland and Japan intervened to stem gains in their currencies. Managers suffered losses as the commodities were down across the board. The Standard & Poor’s GSCI Total Return Index declined -12% in September. Managers also experienced losses long commodity-related currencies as they declined in value. Gold lost its appeal as a safe haven, and prices corrected sharply in September, falling -11%. In fixed income markets, managers experienced gains long U.S. Treasuries and German bunds as yields continued to fall. “Operation Twist” was initiated by the Fed, leading to a 30 to 69 basis point rally in the 10 and 30 year US Treasury yields, respectively.
* 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.
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