Introduction
Hedge funds started the second quarter of 2008 on a strong note, as the composite Eurekahedge Hedge Fund Index rose 1.5%1 on the month. Rallying equity markets, on the back of a sharp increase in risk appetites, coupled with marked reversals across some other asset classes – such as bonds and currencies – were among the factors responsible for the month’s gains. Furthermore, the Fed’s aggressive response (in the form of rate cuts and assistance in the Bear Stearns bailout in March) to the weakness across credit markets and the slowing of economic growth in the US, went some way in improving investor sentiment during April.
In terms of regional mandates, Japanese managers were the best performers in April, with gains averaging 4.2% on the month. While a portion of these unusually high returns can be explained by abnormal gains (in excess of 40%) of some warrant-investing index constituents, a considerably large portion of the gains can be ascribed to the good performance of long/short managers across the region.
Managers allocating to Asia ex-Japan also recorded strong gains, as the index for the geographical mandate was up a solid 2.8%. This was on the back of strong rallies across most regional equity markets, with some (such as Hong Kong and India) turning in double-digit gains on the month. Managers allocating to India, after three consecutive negative months this year, returned an impressive 5.2%, while Greater China-focused hedge funds finished the month up 4.5%.
Latin American hedge funds were up 1.9%, as long exposure to Brazilian and Columbian equities proved profitable for managers. Brazilian equity, fixed income and currency markets also got an added boost from S&P’s move of upgrading Brazil to investment grade, which largely benefited managers allocating to the country.
North American managers, amid an economic slowdown in the region, were up a healthy 1.7% on the month, making a good portion of their gains from equities. However, shorts in equities and in the US dollar (mainly against the euro and the yen) eroded some gains from managers’ portfolio during the month.
The average European hedge fund returned 1.4%, on the back of decent gains from equities, as underlying equity markets rallied. However, shorts in equities coupled with some currency trades (namely long positions in the euro against the US dollar and the yen) proved loss-making on the month, thereby offsetting a portion of the month’s gains.
The chart below illustrates the current month, previous month and year-to-date returns across geographical mandates.
Click on the image for an enlarged preview
Source: Eurekahedge
Global Market Review
The month of April witnessed sharp reversals across most asset classes, as risk appetite returned and money moved from safer-haven assets, such as bonds, into riskier assets, such as equities. Most major equity markets across the board had a strong month this April. The MSCI World Index closed the month up 5%, with its emerging markets component turning in gains of just under 8% on the month. North American equities rose 5% in April, as the Fed’s rate cut in March coupled with their assistance in the Bear Stearns episode, boosted investor sentiment across the region. European equities fared well too, with the MSCI Europe returning 3.9% on the month.
Asian equities had a good month, with several markets bouncing back from their oversold levels and recording double-digit gains during the month. Japan’s Topix rose 12% in April, as banks and consumer electronics stocks performed impressively. Hong Kong’s Hang Seng was up 12.7%, amid strong support from rallying A-shares; banks and oil names were the month’s outperformers. Indian stocks, after declining over 20% in the first quarter of 2008, posted a gain of 10.5% in April, as the fears of a global financial meltdown diminished during the month, positively impacting investor sentiment across the country.
Latin American equity markets also had a healthy month, with the MSCI EM Latin America Index up 9.4% in April. S&P’s upgrade of Brazil to investment grade largely impacted equity markets in the region; MSCI’s Brazilian index rose nearly 15% during the month. Columbian equities fared even better, finishing the month up a whopping 18%.
Fixed income markets were weak across the board, throughout April, as the return of risk appetite catalysed the flow of money into riskier assets. Furthermore, persistent concerns on inflation added to the stress on the fixed income markets. Treasury yields in the US rose during the month; yields on the US 10-year T-note and the US 90-day T-bill rose 33 and 7 bps respectively. Bond markets in Japan were also lower on the month, as the price of the 10-year JGB was down 3% on the month.
The currency markets witnessed a marked appreciation in the US dollar, as signs of the Fed halting their rate cuts brought about expectations that the US would be able to weather the ongoing credit crisis. The US dollar strengthened 1% against the euro after initially touching a record low during the month, and was up over 4% against the yen. However, the US dollar declined 3.3% against the Australian dollar, as higher risk appetites saw increased demand for higher-yielding currencies.
In the commodity markets, crude oil rallied to touch a record high during the month, on concerns regarding the supply of the same from Nigeria and discouraging comments from OPEC. Agricultural commodities recorded mixed movements, while precious metals (particularly, gold and silver) closed the month down 7%.
The chart below illustrates the current month, previous month and year-to-date returns across hedge fund strategies.
Click on the image for an enlarged preview
Source: Eurekahedge
Performance of Strategic Mandates
A) Arbitrage and Relative Value
Arbitrage and relative value managers finished the month of April up 0.7% and 0.3% respectively, amid an environment of lower volatility (as compared with the past few months) and tighter credit spreads across the board.
North American arbitrageurs and relative value managers turned in gains averaging 1.2% and 0.4% respectively. Managers across the region made some gains from merger arbitrage trades, although M&A activity appeared to be slow. This was partly due to the difficulty in obtaining funds for leveraged deals, leading to an increase in the number of strategic deals across the market. In addition, rallying convertibles and improvements in financial- and REIT-related papers worked to the advantage of managers in the region.
In Europe, arbitrage and relative value managers returned -0.1% and -1.2% respectively. While long positions across equities (particularly in select large caps with reasonably low valuations) fetched some gains on the month, bets on high short-term volatility were hit hard during the month. These coupled with unanticipated movements in the currency markets, more than offset the gains realised during the month.
Relative value managers allocating to the Asia-Pacific region finished the month up a healthy 2.4%. Australia-focused managers of the strategy made some decent gains from statistical pair trades across the banking, property and infrastructure sectors, while managers investing in Asia largely benefited from their exposure to the equity markets, which rallied strongly during the month.
Click on the image for an enlarged preview
Source: Eurekahedge
B) Long/Short Equities and Event-driven
Long/short equity managers recorded impressive returns across the board, as most major equity markets staged a strong rally during the month. The MSCI World Index finished the month up 5%, against which, the Eurekahedge Hedge Fund Index returned 2.3%.
In terms of regional mandates, the best performing long/short managers were those allocating to Asia. Japanese managers returned 2.9%, making some healthy gains from long positions across banks and consumer electronic names, among others, during the month. Those allocating to Asia ex-Japan were up 3.3% on the month, on the back of sharp increases across equities in Hong Kong and India, among other regions.
Indian managers turned in gains to the tune of 6.6%, largely benefiting from long positions in sectors such as software, telecom and financials. Better-than-expected results for the quarter end-March 2008 lent some support to underlying equities during the month; small- and mid-caps were the month’s outperformers. Greater China-focused funds registered returns averaging 3.9% as exposure to stocks in Hong Kong proved profitable; long positions in banks and oil companies resulted in decent gains during the month.
Korean managers were up 2.2% on the month, against a 7% increase in the Kospi; long positions in the banking sector, among others, benefited managers. Taiwan-focused funds returned 3.9%, against a 4% increase in regional stocks; gains were realised mainly during the second half of the month, as equities rallied. Australia-focused managers returned 2.9%, making decent gains from long exposure to banks and the resources sector, and from short positions in industrials.
North American and European long/short managers returned 2.3% and 1.5% respectively; the former made healthy gains from long exposure to economically sensitive sectors, while the latter benefited from long positions in the energy, materials and IT sectors during the month. In terms of regional equity indices, the S&P 500 was up 4.8% during the month, while the FTSE 100 in Europe, rose 6.8% on the month.
Event-driven managers had a strong month too, as the Eurekahedge Event Driven Hedge Fund Index rose 1.4% on the month. European managers of the strategy turned in the best returns, in terms of regional mandates, with the regional index up 3.7%. This is partly on account of one of the constituents having returned in excess of 8%, thereby positively skewing the average. As for the other funds in the index, gains came from rallying equities and from some special situations across the region, such as in the case of Plethora – a pharma company – which struck a rather innovative financing deal with a private equity firm in the region.
The Eurekahedge North America Event Driven Hedge Fund Index, which has a larger number of constituents, was also largely skewed by a fund that returned in excess of 25% on the month. As for other
managers, strategically planned deals (owing to the lack of easily available funding for leveraged buy-outs) afforded them with decent opportunities to profit from.
Event-driven managers allocating to Asia Pacific were up 1.2%. Some managers benefited from trades in the technology sectors of markets in Taiwan, India and Korea, while some others allocating to the Australia markets benefited from takeover arbitrage positions, on the back of some corporate activity in the region.
Click on the image for an enlarged preview
Source: Eurekahedge
C) Fixed Income and Distressed Debt
The Eurekahedge Fixed Income Hedge Fund Index finished the month of April absolutely flat (0.04%).North American managers were up 0.7%, as short positions across treasuries fetched some gains; yields on the US 90-day T-bill and the 10-year T-note rose 7 bps and 33 bps respectively, on the back of a sharp decline in risk aversion. A notable tightening in credit spreads also went some way in benefiting fixed income managers.
European fixed income hedge funds were up a solid 3.1% on the month. Managers largely benefited from their exposure to financial credits, which did well partly owing to new issuances by banks across the region. Furthermore, marked tightening in corporate credits – both on CDS and cash bonds – assisted managers in making their month’s gains.
Latin American fixed income managers were up 1.2%, benefiting partly from their exposure to the Brazilian fixed income markets, which fared well during the month.
Distressed debt managers were up 1% on the month, with North America-focused managers of the strategy up a healthy 1.3% on the month. A sharp rebound in the high yield market after a rather rough first quarter, coupled with considerable tightening in cash spreads, were among the factors that assisted managers across the region. European and Asian managers finished the month relatively flat (0.4% and -0.04% respectively)
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Source: Eurekahedge
D) CTA/Managed Futures and Macro
After a strong first quarter this year, CTA/managed futures managers started the second quarter with returns averaging -0.4% in April. In terms of regional mandates, Europe was down 1%, while North America-focused managers lost 0.4%. Losses across both the regions can be partly attributed to unforeseen movements across the currency markets (namely the unanticipated decline of the euro against the US dollar) and mixed movements across the commodity markets.As for macro managers, they registered returns averaging 1.9%. Managers of the strategy made a large portion of their gains from equity markets across the board; while a number of trades in the currency markets and some in the commodity markets went some way in offset gains from other allocations.
Latin America-focused macro managers finished the month up a healthy 4.1%, partly because two index constituents – which comprise nearly one-thirds of the index – turned in gains in excess of 8%. Other managers fared considerably well too, benefiting from their exposure to the Brazilian markets, and to equities and currencies in Columbia.
Macro managers with broader regional mandates, with exposure to Europe, North America and Asia were afforded with healthy opportunity across the equity markets of the respective regions. However, currency trades (for managers betting against the US dollar against the euro and the yen) and commodity trades (for managers betting against a further rise in oil prices, among some other commodities) went some way in eroding gains during the month.
Click on the image for an enlarged preview
Source: Eurekahedge
E) Multi-Strategy
Multi-strategy managers registered returns averaging 0.9% on the month, as trades across most investment strategies resulted in positive returns during the month. North American managers were the best performers of the strategy in April, with returns averaging 2.8%. A large portion of the returns across the region, as in the case of most other regions, can be attributed to the performance of regional equities. Managers that bet on an increase in the US dollar also realised decent gains during the month.European managers finished the month flat to negative, with the index down 0.8% mainly due to a constituent having lost over 15% during the month. On the whole, managers made decent gains from their positions across the equity markets, a portion of which were eroded from currency trades, owing to a 1% weakening of the euro against the US dollar.
Asia-focused funds were up 1.3%, as managers made gains from equities, among other things, across the Asia-Pacific region. However, unforeseen movements across currencies (such as the 4% weakening of the yen against the US dollar), offset some of the gains realised from other allocations.
Managers in Latin America turned in gains averaging 1.5%, with the best performing index constituents being invested in Brazil. Markets in Brazil fared impressively, with their performance being catalysed by S&P’s upgrade of the country to investment grade; the move benefited the equity, fixed income and currency markets in the country. Additionally, a rally across Columbian equities and the strengthening of the Columbian peso against the US dollar, also went some way in working to the benefit of managers across the region.
Click on the image for an enlarged preview
Source: Eurekahedge
In Closing
April saw some welcomed changes, in terms of reversals across some asset classes and in risk appetites across the board. Equities rebounded from their oversold levels, while the currency markets witnessed appreciation in the US dollar against some major currencies.
The Federal Reserve delivered yet another rate cut this year, on 30 April, bringing the Fed funds rate to 2% – the lowest in over three years. This rate cut, however, was accompanied by a statement hinting that the Fed might now shift their focus from economic growth to inflation. This statement has been interpreted rather differently by market participants across the board. Some have inferred that most of the troubles related to the US subprime meltdown and the consequent credit crisis are now behind us, while many others strongly believe that it is only the first phase of turbulence that has subsided.
Such clashing opinions, coupled with the varied outlook of hedge fund managers (and other market players) on equities, currencies and commodities, may well result in some amount of pricing inefficiencies across the asset classes in the near future. These pricing inefficiencies, however, often work to the advantage of some hedge fund strategies, such as arbitrage and relative value, among some others. Additionally, the sharp rallies across equities seen through April and the decent performance of equity markets (except those of Emerging Asia) in May, so far, could help in further strengthening the market sentiment. This could in turn work positively for managers across the board.Footnote
1Based on 61.03% of the funds reporting the April 2008 returns as at 16 May 2008.
