Hedge Fund Performance Commentary

Global markets breathed a sigh of relief after the US presidential election, and October returns marked the beginning of renewed confidence in a sustainable recovery in the United States and in the Asia Pacific. A steady search for profits continued to push share prices cautiously higher. In line with these increases was the ABN AMRO Eurekahedge Asia-ex Japan Index, which was up 1.04% for the month of October.

Event-driven and distressed debt funds continued their pace setting gains for 2004 with a 2.71% and 2.25% gain for October, respectively. While each event driven fund tends to present a unique story, the competitive bidding for Australian Leisure and Hospitality and the announcement to take the holding company for Hollinger International private helped portfolios. Distressed debt funds benefited from improving credit trends across Asia. This was particularly the case in Indonesia, where a smooth transition of power allowed funds to benefit from repurchase arrangements on previously tight bond covenants.

Macro strategies, while early in the month fighting general losses on equities in response to record oil prices, posted a 1.4% gain for October. The returns were positively skewed by a few outliers who made dramatic gains as the yen and other Asian currencies appreciated against the dollar. Additionally, emerging market equity continued to be the year's hot sector; the Ashmore Emerging Economy Portfolio gained 7% last month. Given the tension between the Asian economies, which continue to quietly purchase US debt, and the US, which continues to supply it, the macro and global fixed income funds betting on interest rates should see some interesting opportunities in the near future.

Fixed income returns were similarly pulled up by emerging market debt funds, while those fixed income funds that were distributed long around the Asia Pacific region picked up gains as credit conditions continued to strengthen in all Asian countries except for the Philippines, which is currently mired in a "fiscal crisis," according to its President, Gloria Arroyo. Countries continued to tighten currencies to prevent inflation from countering gains: besides China, Taiwan also raised rates in October. Global risk aversion brought US yields down, as speculation was much less aggressive (i.e. in commodities) than in September.

In general, the trendless regional markets made profit taking difficult for relative value and arbitrage funds, although volatilities were up slightly in October, in a momentary departure from the year's low levels. However, the first parts of November have seen volatilities slip again, and the markets remain liquid and cash-heavy.

Strategy October Return Last 3m Return YTD Return
Convertible Arbitrage -0.64 -0.76 -0.92
CTA 0.92 -1.34 -4.44
Distressed Debt 2.25 5.63 12.91
Event Driven 2.71 5.30 16.29
Fixed Income 1.26 3.43 4.68
Long/Short Equities 0.62 2.60 4.59
Macro 1.40 0.17 -4.03
Multi-Strategy 0.87 2.77 8.56
Other 0.01 -1.57 10.14
Relative Value -0.09 0.50 2.21
ABN AMRO Eurekahedge Asian Hedge Fund Index 0.48 1.63 5.90

The gain in the Eurekahedge index came despite Asia's share of challenge to portfolios this month, particularly with China's first interest rate increase in nine years and the subsequent drop in commodities for fear of a China slowdown. Japan's lower-than-expected industrial output also hurt returns. However, Asian share prices were boosted by gains in currencies across the board. The drop in the US dollar has been the most potent contributor to this increased demand for Asian money. Generally this is good news for Asia, as the appreciation mitigates inflationary pressures from oil and commodities. An apt example is Korea, whose central bank neglected to curb the won's appreciation to a four year high. As a result, Korean-allocated funds gained 3.5% in October (and 6.5% in the last three months), largely due to portfolio currency gains, as the domestic economy continued to falter.

Geography October Return Last 3m Return YTD Return
Asia ex-Japan 0.70 4.03 0.28
Asia incl Japan 1.02 3.03 2.48
Australia / New Zealand 2.13 5.00 10.92
Emerging Markets 1.31 5.17 4.68
Global 1.34 2.99 3.02
Greater China -0.17 1.21 -0.34
Japan only -0.43 -1.82 8.44
Korea 3.50 6.50 7.17
Taiwan 0.06 0.64 5.59
ABN AMRO Eurekahedge Asian Hedge Fund Index 0.48 1.63 5.90

China and Japan posted declines, although the prospects for both countries are solid. Regionally, Japan lost 4.3% in the face of continued lacklustre consumer demand, high oil prices, the Niigata earthquake and a cyclical sell-off with a perceived China slowdown. Both China (the only other region down for the month at -0.17%) and Japan felt negative shock waves from a declining dollar, although China's interest rates and its falling commodity prices also dampened investment sentiment. However, China's growth continues, and the recent monetary liberalisation bodes well for the future. Also, while production reports in Japan were disappointing, corporate balance sheets are generally strong and unburdened by debt, which indicates a continued recovery. On another positive note, Australia's resources prices contributed to a 2.13% gain for funds allocated there, and the country's economy should continue to be a bright spot in the Asia Pacific macro story.

Going forward, all eyes will be on US interest rates. While most debt analysts expected the Fed to hold off on yet another rate increase, recent inflation figures have caused most managers to revise their predictions. Expect another quarter point uptick in the next meeting, especially if the dollar continues to drop. If this happens, Asian banks will probably consider currency intervention. Also, the interest rate hike in China must be viewed with a grain of salt, as the move merely indicates official commitment to slow the economy and is unlikely to have material effect in the near term. Moreover, the RMB would have to be drastically revalued to slow inflation substantially. But if China continues to loosen its monetary policy, Asian currencies will reap the benefits, and this boost will supplement improving company fundamentals in Japan, and may in fact push the Nikkei average on a steady climb to 11,000.

Lastly, if American consumption can continue as an engine of growth through the holiday season and China can continue to manage a soft landing, the prospects around the corner into 2005 are quite positive.