October turned out to be a poor month for
hedge funds across the board. In a marked
departure from the positive to spectacular
returns seen in the last five months, almost
all the Eurekahedge regional indices took
a southward turn. The exceptions were Japanese
hedge funds (the Eurekahedge Japan Hedge
Fund Index was up an impressive 1.7% for
the month), and to a much lesser degree,
onshore Latin American hedge funds (whose
corresponding index was up 0.6% during the
same period). The North American and European
indices, on the other hand, registered negative
returns of 1.3% and 1.8% respectively.
There was no major catalyst to blame for
the month's turnout. Corporate and macro-economic
fundamentals were generally optimistic.
It was really a month of short-term market
correction of the variety August saw a hint
of (in the form of a dip in the return-gradient),
but was more pronounced by a spate of profit-taking.
Global inflationary pressures also got the
better of investors' risk appetites and
exacerbated the fall.
To speak more specifically from the perspective
of hedge fund performance, the market was
also influenced by rumours of redemptions.
However, new issuance is still robust. This
has improved pricing towards the end of
the month, marginally in Europe and more
pronouncedly in Japan, and kept demand strong.
With the past few months' returns driving
a bullish market sentiment, many funds have
also been unable to exit bad positions quick
enough, setting off a stop-loss panic.
The key events guiding market trends in
October were 1) the announcement of Ben
Bernanke as the new Federal Reserve chairman,
2) the REFCO crisis and the issue of counterparty
risk, and 3) worsening inflationary pressures
in the US.
In short, a decline in risk appetite coincided
with a technical correction, and hit hedge
fund returns across almost all regions,
the trends wherein are discussed in greater
detail in the following pages.
The US equity markets, which showed a certain
resilience in September in the face of back-to-back
hurricanes and energy-related disruptions,
plunged during early October although they
recovered some lost ground during the later
part of the month. The S&P 500 Index
and the NASDAQ Composite Index were down
1.8% and 2.5% respectively for the month.
Also, a string of factors/events
the announcement of Ben Bernanke as the
new Federal Reserve chairman, the earnings
season, declining oil prices kept
the equity market movements highly volatile.
The treasury markets continued on their
downward path from September, with 10-year
yields rising from 4.3% to 4.6%, amidst
the Fed's concern over inflation and its
persistence on short-term rate hikes. Despite
the rate-hike policy, or rather because
of it, the markets finally saw a steepening
of the yield curve, with the spread between
2-year and 10-year notes rising from 16
to 37 basis points.
Energies too had a bearish run in the month
leading up to the winter/heating season.
This owed to the fact that there were lesser
supply blockages and warmer weather, than
the markets had earlier expected. The production/refining
facilities incapacitated by the hurricanes
of the past few months were also brought
back on track during the month. Crude prices
dropped from US$66 to nearly US$60 per barrel.
Similarly, gasoline was down 27% and natural
Hedge Fund Performance
Fixed income funds were the only ones
that finished the month in positive territory
in the North American universe, returning
0.4%. Managers predicting an inversion of
the yield curve based on the narrow-spread
trend of the past few months and the Fed's
stand on short-term rate hikes would have
pulled down the average return figure for
In the US event-driven space, adverse price
movements in the underlying asset classes
of many merger arbitrage opportunities (for
a variety of reasons such as tougher financing
conditions and events impacting specific
deals), helped explain the sub-normal returns
generated by these funds for the month.
Case in point: the drop in the stock of
Spinnaker Exploration Co (to be acquired
by Norsk Hydro) after fears over an assumed
breach of a clause in the deal. Other major
blows for US event-driven funds came from
such deals as Petrokazakhstan - CNPC, Guidant
- Johnson&Johnson and School Speciality
- Bain Capital.
The volatility of the equity markets, on
the other hand, took its toll on long/short
funds. These funds were also hit by companies
reporting lower-than-expected fundamentals.
North American Hedge Fund Index
The US economy continues to see inflationary
pressures building. Coupled with robust
micro-economic indicators for October, this
would mean that the Fed can be expected
to continue with its credit-tightening policy
in the near term.
European equities also plummeted during
the month, with the MSCI Europe Index down
2.6% for the month. Energy-related stocks
were the worst-hit as they had to absorb
the impact of the twin fall in oil prices
and equity markets. This had a direct bearing
on the performance of oil-sector-heavy markets
such as Norway, which was down 7.9% for
European bond yields rose sharply (over
20 basis points for the month), also triggered
by mounting inflationary pressures and the
ECB's hawkish comments. A hike in the index
rate before the end of the year is expected.
Emerging equity markets in Europe registered
a steep decline in October, with the MSCI
EMEA Index returning -7.1%. This profit-taking
spree was spurred on mainly by rising global
inflationary fears. Russian equities followed
suit too, betraying their over-dependence
on strong oil prices for their economic
well-being, and by extension, their structural
South African equities witnessed an even
more pronounced fall at -10.3%, accentuated
by the weakness of its currency against
the dollar. Mining stocks, however, did
well through a combination of weak currency
and strong metal prices.
Hedge Fund Performance
Arbitrage funds were the only ones with
positive returns for the month, although
at a miniscule 0.2% for the month. There
were enough players/long-portfolios hit
by the downward trend, which was in turn
brought on by a combination of factors such
as the oil price decline, profit-taking,
and concerns over redemptions, to almost
nullify any positive ground the rest of
the players or the hedge/short portions
of their portfolios might have gained. Also,
convertible arbitrageurs had it rough because
of the decline in the equity market.
On the other hand, multi-strategy funds
were the worst performers during October,
drawing the Eurekahedge European Multi-strategy
Hedge Fund Index down by nearly 2.5%. With
almost all sectors and asset classes taking
a turn towards the negative, diversification
was not of much help.
A reasonable portion of the funds were
oil-sector heavy, and precisely these sectors
oil & gas (-7.4%), auto &
parts (-7.5%) and transportation (-6.6%)
were the worst-hit during the month.
This, coupled with the general weakness
of the equity markets, explains why long/short
funds and event-driven funds fared poorly.
European Hedge Fund Index
European economic data was largely positive.
Eurozone core inflation, at +1.3% year-on-year,
was below expectations. M&A activity
is on the rise, spelling a greater breadth
of opportunities for arbitrage, event-driven
and special-situations players. Valuations
in European equities are also attractive,
as evidenced by recent large cash deals,
such as Telefonica's US$12 billion bid for
Japan was the only exception to the trend
of plunging equity markets. Topix returned
a very healthy 2.3% for the month, while
the Nikkei 225 was up 0.2% for the same
period. But these numbers don't tell the
complete story Japanese equities
underwent a phase of sharp volatility earlier
in the month (with the Topix experiencing
its largest drop and its largest rise for
the year, within a span of a week), followed
by a steep decline mid-month and then a
steep recovery in the last few days to finish
the month in positive territory.
This positive turn can be attributed to
timely interim results announcements that
were generally upbeat. Also, Japan's quarterly
Tankan survey came out lower than expected,
and the inflation numbers continue to be
deflationary. The US markets' positive reaction
to the announcement of the Fed's new chairman
also had its effect.
Hedge Fund Performance
Quite unsurprisingly, the same strategies
event-driven, long/short and multi-strategy
funds that bore the brunt of the
markets' downward movement in the US and
Europe were the ones that benefited from
the end-of-the-month trend reversal. The
Eurekahedge Japan Event Driven Fund Index
rose a spectacular 2.9%. M&A events
such as Fuji Heavy Industries Ltd's announced
tie with Toyota Motor Corp, after calling
off its alliance with General Motors, helped
returns. The key performing sectors were
banks, insurers and small caps. Cyclicals
and pharmaceuticals were some of the weak
Relative value funds, on the other hand,
were hurt by the see-sawing of the markets
and were the worst-performing and the only
negative-return-generating strategy for
Japan Hedge Fund Index
In Japan too, as in Europe, corporate valuations
are good, and companies are reporting positive
returns. Furthermore, investment inflows
continue to be healthy, and as reaffirmed
by trends we have observed in the past few
months, Japan is reasonably insulated from
adverse global market-moving events in the
US. The upward movement in the market may
be reasonably expected to continue.
Markets in the rest of Asia, on the other
hand, could not escape the almost overarching
trend of inflationary pressures leading
to lowered risk tolerances and to earlier-than-expected
securing of year-to-date returns, despite
healthy micro-economic data. The MSCI AC
Asia-pacific ex-Japan Index fell 6.4% during
the month. Investors' revived enthusiasm
for the Japanese market has also drawn away
some of the attention to the rest of the
region. Asian markets also had the avian-flu
scare to contend with. Increased capital-raising
activity, of which the huge IPO by China
construction bank is but an example, has
also put pressure on the Asian markets by
siphoning off some of their liquidity.
There was a general erosion of value across
asset classes and regions. In Australia,
the ASX 500 fell 3.9%, owing not just to
global market movements but also due to
lack of any clear corporate earnings guidance
during the AGM season, while the Australian
currency weakened against the US dollar.
The big losers for the month were energies,
industrials and materials. However, the
Index saw some gains towards the end of
In Korea, the KOSPI fell by 5.2%, with
foreign investors becoming net sellers of
US$2.5 billion for the month. Hong Kong's
Hang Seng H-share Index was down 6.9%. In
India, the Nifty Index was down 8.8%, while
the Indian rupee recorded its worst monthly
loss for the year depreciating 2.5%, with
foreign institutional investors becoming
net sellers of about US$840 million.
Nevertheless, market participants continue
to be upbeat about macro-economic fundamentals
and corporate valuations, as well as in
growth expectations, particulary in China's
growth. Q3 numbers show Korea grew 4.4%
year-on-year in the third quarter, exceeding
market expectations on consumption and exports.
Chinese economy grew at 9.4% in Q3.
Hedge Fund Performance
Event-driven funds closed the month flat
at 0.01%, and have bucked the negative-return
trend through the increased level of activity
in the region's M&A and capital-raising
space. Long/short funds were the worst hit
for the month drawing the corresponding
Eurekahedge Index down 3.2%, owing to most
funds reaching their stop-loss limits in
steeply trending markets. Multi-strategy
funds also experienced erosion of value
as the decline hit almost all asset classes
and most of the economies in the region.
All this was reflected in the rather poor
showing of the Eurekahedge All Strategy
Asia ex-Japan Hedge Fund Index, which returned
-2.7% for the month.
ex-Japan Hedge Fund Index
While global trends such as mounting inflationary
pressures and declining US consumption persisted,
the month's decline is largely attributed
to a short-term market correction, and a
"nudging ahead" of what is typically
a pattern seen towards the end of the year.
Indeed equity markets in most Asian equities,
including Korea, India and Australia are
on the rebound, going by end-October and
early-November market data.
In Latin America too, the markets were
generally weak and highly volatile, staging
recoveries only towards the close of the
month. The MSCI Latin America Equity Index
dropped 5.5%, although the situation was
less grim in a sector-wise review of movements
in equities oil-related stocks suffered
losses of about 10% but telecoms had a good
run in Mexico, Chile and Brazil. Emerging
bonds also got dragged down by the US treasury
market movements. A devaluation in the currency
further hit Argentine peso bonds.
And yet, most economies saw an improvement
in fundamental/fiscal health. Global growth
indicators remain strong and so do corporate
earnings figures. For instance, the political
crisis in Brazil has had no appreciable
impact on either market movements or the
general popularity of the Lula establishment;
things look positive on the economic front
too, with Brazil registering a large trade
balance surplus and healthy growth in international
reserves. In Argentina, the re-election
of the incumbent president in the recent
country-wide elections was a reaffirmation
of the success of the government's policies.
Hedge Fund Performance
Among Latin American hedge funds, onshore
funds outperformed offshore funds, even
showing positive returns at 0.6% for the
month. This should come as no surprise,
as the key catalyst in the month's decline
across the board was profit-taking investors,
and it was the onshore funds that enjoyed
the most surges in liquidity over the past
Moving on to a more specific review of
the performance of Latin American funds,
long/short and pair-trading funds had the
same story to tell of the short side
being less hurt than the long side, and
not entirely hedging the loss component.
These funds were consequently down a staggering
4.8% for the month, drawing down the overall
index to a rather poor -2.5%. Onshore funds
allocating to the relative value strategy
also got hurt, returning negative 3.9% for
Offshore funds allocating to other strategies
had a relatively better time, with most
of them returning under -1%.
Among the better performing onshore funds,
CTA and fixed income funds had a good run.
This may be explained by the fact that Latin
America is particularly sensitive to US
treasury yield rallies because of its heavy
sovereign debts and also because its main
exports are commodities. Funds that understood
that commodity prices could therefore be
affected negatively in an environment of
rising interest rates fared well in October.
Latin American Offshore Hedge Fund Index
American Offshore Hedge Fund Index
The outlook for emerging markets is still
largely positive because the economic fundamentals
are in some cases (such as India, Brazil)
even more robust than in developed economies.
Equity trends from early November are also
positive. So while inflationary pressures
and investors' risk aversion hover on the
market scene, profit-taking investors may
be expected to be drawn back by the positives.
To conclude, October's market movements
were largely the result of a short-term
market correction. There was a hint of it
in August (as evidenced by the dip in that
month's return gradient), but not the spate
of profit-taking and the subsequent panic-selling,
that was seen in October. But why do we
think that this is just a short-term correction?
The MSCI Europe Index had its best run of
the year on the last trading day of the
month. Japanese equity indices too recovered
most of the month's losses in the last few
days of trading. Other emerging market equity
indices also showed similar trends. But
more importantly, almost all the emerging
markets that saw a draining of liquidity
and significant draw-downs, were economies
which had positive, if not strong, fundamentals.
So while the following end-of-the-year
months could be a little unpredictable just
like this one, owing to lowered risk appetites,
we expect market trending to return to more
normal and healthy patterns in the near
on 73.69% of the NAV data for October received
to date (2 December 2005).
2The All Strategies
Index is a separate index and derives its
value not only from the actual performance
of the listed strategies for the investment
region but also from the strategies which
are not listed (due to strict Eurekahedge
indices guidelines) but having the same
Preliminary NAV returns
for November indicate returns in the 0 to
2.5% range. Please visit ../indices
for a daily update on index returns.