Hedge funds had a spectacular run in September,
reflecting the significant boost to market
activity from a sluggish August. Most Eurekahedge
regional hedge fund indices were up on the
right side of 3% for the month, as is evident
from the graph below. Even the under-performing
region, North America, registered a spike
in its return gradient, rising 1.27% to
The key events dominating the month's market
scene were 1) the Federal reserve's hiking
of its funds rate by 25 basis points to
3.75%, accompanied by feelers about further
hikes in the near future to stem inflationary
fears; and 2) the ravaging effects of hurricane
Rita on key oil refining and production
facilities in the Gulf region of the US,
not to mention its timing (in the wake of
Katrina, as also right before the energy-demand-heavy
winter months). Their impact on the US bond
and commodity markets, respectively, is
not surprising in hindsight. More region-specific
repercussions of these events are discussed
under the relevant sections elsewhere in
September's performance trends were similar
to, if more pronounced than, those seen
in August. For instance, Japan and Latin
America retained their positions as key-performing
investment regions, and market sentiment
there continues to be positive and strong.
Furthermore, Europe, Japan and Emerging
markets continued to be resilient to energy-related
events in the US. Also, oil and energy-related
stocks continued to post healthy increases
in economies like Brazil and Russia.
Moving on to some of the notable dissimilarities
between monthly trends in August and September,
global bond markets witnessed a reversal
of the rally in prices seen in August, as
a fallout of the Federal Reserve's rate
hikes. Bond yields went back to pre-August
levels. The month also saw high volatility
in the global energy markets, in place of
the price rally of the past few months.
Fears over the effect of the hurricanes
on US economic growth helped push the prices
down, with price elasticity of demand for
oil also finally kicking in.
The stellar performance of hedge funds
in September was primarily driven by booming
equity markets across the board, certainly
helped by movements in the bond markets.
Naturally, equity long/short funds registered
fabulous gains almost unanimously across
all regions. Also, the drop in bond prices
contributed to the under-performance of
the related hedge fund strategies such as
relative value and convertible arbitrage,
in some of the regions. High volatility
in the commodity markets had a similar negative
impact on the performance of CTA/managed
futures funds, in other regions.
In the aftermath of two back-to-back hurricanes
that hit the Gulf region in the US and disrupted
oil production and refining capabilities,
commodity prices shot up but the equity
markets seem to be showing a certain resilience.
The latter registered marginal gains in
September, with the S&P 500 index up
0.69% and the NASDAQ Composite Index down
0.02%. While the Federal Reserve's interest
rate hike could not have helped, the markets'
belief that the hike may be placed on hold
as also the stimulatory effects of the financial
aid that would flow into the region, assisted
the equity markets on their way up.
The US Treasury markets on the other hand,
experienced a reversal of the rally seen
in August, following hawkish comments from
officials of the Federal Reserve. Yields
are back up at end-July levels 10-year
yields rose to 4.32%, up from 4.02%; 5-year
yields rose from 3.87% to 4.19%. Despite
the higher interest rate environment, the
trend of a flattening yield curve continued
with the spread between the 2-year
and 10-year notes narrowing a further 4
basis points from 20 (down from 28 in August)
to 16 amidst the Federal Reserve's
recipe of higher short-term rates for the
rest of 2005.
And in the currency markets, the dollar
strengthened against the euro and the Japanese
yen, on expectations of further tightening
by the Federal Reserve.
Hedge Fund Performance
The macro strategy was the best-performing
among hedge funds allocating to North America,
posting excellent returns at 3%. Funds have
benefited from the global trends of rising
inflation and inflation risk on one hand
and steady economic growth on the other.
Equity long/short funds were the next best
return generators in the region, up 1.65%.
Oil service stocks were the key drivers,
especially those in a position to provide
the requisite equipment and services for
the rebuilding of the Gulf Coast infrastructure.
Convertible arbitrage funds turned in decent
returns, considering all the negative press
and poor performance earlier this year.
However, due to the contraction in convertible
assets of between 30-50% over the past year,
convertible hedge funds are finding it more
difficult to eliminate inefficiencies quickly.
Event-driven funds have had five consecutive
months of good returns so far. September's
returns were driven by the impressive momentum
shown by the M&A markets. Deals of note
in the US were Oracle's US$5.4 billion bid
for Siebel, and the announced alliance between
Wellchoice and Wellpoint an example
of continuing consolidation in the health
insurance sector. Statoil's acquisition
of Spinnaker, a Gulf of Mexico-focused exploration
company, also lent a fillip to the oil sector.
CTA/Managed futures funds, on the other
hand, had to contend with highly volatile
energy markets and were consequently the
worst performers for the month. For instance,
the price of unleaded gasoline was down
5% after trading in a range of about 30%,
while that of natural gas was up 20% and
heating oil remained more or less flat.
This volatility is reflective of market
participants trying to assess the extent
of the damage caused by the two hurricanes,
in their investment decisions.
Going forward, the energy sector in particular
is expected to remain unstable and illiquid,
as the problems are structural and need
to be solved over time. The resulting pressure
on inflation and consumer confidence may
create opportunities for hedge funds. Also,
despite the damage inflicted by the hurricanes,
the prospect of increased fiscal spending
should keep the US economy going in the
coming months. Other opportunities for funds
may be sought in the inflationary pressures.
On the negative side, corporate trends such
as the recent corporate accounting issues
at Fannie Mae and REFCO, and Delphi's bankruptcy
filing, may add to pressure on high yield
European equity markets rallied in September
on the strength of corporate data (earnings
as well as corporate activities), and showed
continued resilience to rising commodity
prices. The MSCI Europe Index rose 4.4%
and the CAC40, the main industrial index
on the Paris Stock Exchange, rose 4.6%,
in September. Attractive valuations, increased
M&A activity and share buybacks, have
all had a positive impact on market movements.
But there is a dichotomy in the earnings
pictures painted by the industrial and the
retail sectors. While the former are enjoying
strong demand, the latter are suffering
from weak demand from consumers and rising
prices on the supply side.
On another level, Europe has a different
sort of dichotomy politically both
the government and the people are resilient
to reforms. But economically, corporate
earnings and cash generation are good, and
are driving activity in the capital markets.
In the bond markets, concerns over growth
and inflation amidst a higher interest rate
environment in the US, were not without
their mirror effects in Europe. For instance,
10-year yields rose from 3.1% to 3.15% in
Germany. On a related note, the impact of
the German election outcome on the markets
is yet to be fully evaluated.
In Eastern Europe, the revision of the
budget deficit in Hungary sent the bond
and currency markets southward. Turkey's
impending official commencement of EU talks
(3 October), has increased overall market
volatility. Russia's bond markets remain
strong, backed by a fiscally efficient government.
Likewise with its equity markets, driven
by high metal and oil prices. There is also
high liquidity in the market, with strong
Hedge Fund Performance Tables
Multi-strategy funds were the top income
generators in Europe, rising by over 4%
for the month.
Funds allocating to the
commodity markets on the other hand, were
the worst performers for the month, posting
negative returns of 0.4%. This mirrors the
trend seen in hedge funds allocating to
North America, and is for the same reasons
Europe seems on course to sustaining its
bull run with low valuations and operationally
sound companies. Inflation and expectations
of inflation do not seem to be a cause for
immediate concern, despite the rising energy
prices. This would be a conducive environment
for skilled stock pickers.
The Japanese markets had an incredible month
in September. The TOPIX rose 11.5% while
the Nikkei 225 rose 9.3%, for the month.
The bullish trends seen in August followed
through, fuelled by the (positive) outcome
of the Japanese general elections as well
as healthy economic data. And the minimal
impact of global commodity prices on the
markets reinforces the trend also
seen in August of Japanese markets
performing well independently of the US
The anticipated expansionary cycle would
be different from other recoveries as domestic
demand is playing a key role. Movements
in the equity and real estate markets further
corroborate this. Foreign institutional
investors remain very strong buyers in the
Hedge Fund Performance
Amidst prevailing market sentiment about
the end of deflation and start of the expansionary
cycle in the near term, the key performing
sectors in the Japanese equity markets were
banking and retail stocks.
Event driven funds also posted very high
returns at 3.5%. September saw a rise in
the number of stock splits. Also there were
realised profits for funds, from M&A
deals invested in and whose merger dates
fell within the month, such as those of
Bank of Tokyo-Mitsubishi, and CITIZEN.
Relative value funds are the seeming under-performers
for the month, but even they have bounced
back from the negative territory in August,
to posted good returns at slightly over
The Bank of Japan is hinting at hiking interest
rates. Coupled with an increasing corporate
demand for funds, the interest rate hike
will prove beneficial to the banking sector.
Inflation is unlikely to pose a problem
in the near future, as the markets expand.
The rising markets (there have even been
recent announcements of strong Japanese
export data) should afford ample opportunities
for hedge funds, especially in the equity
and bond markets.
Asian markets also had a very good run in
September, with Korea and India as key drivers.
The MSCI AC Far East ex-Japan Index rose
4.8%, while the KOSPI rose an incredible
11.9% and the BSE Sensex was not far behind
at a 10.4% boost. In the Asian bond markets,
the reversal in US yields has had the effect
of limiting bond prices within a tight range.
Corporate Korea's share buybacks also boosted
the market to new highs.
In India, the driving factors for the strong
run were steady bond yields, declining inflation
and global liquidity.
China's markets also finished the month
higher; the Hang Seng Index was up 3.5%
for the month. As well, China is experiencing
a build-up in liquidity as evidenced
by July's trade surplus numbers (US$10.4
billion) and a surge in equity from IPOs
and share placements suggesting a
bullish forecast for October. China also
decided to widen the daily trading range
of the yuan against non-USD currencies.
Another factor fuelling this bullish forecast
is the much-anticipated China Construction
Bank IPO. At an estimated US$6 billion,
it is being billed as one of the largest
IPOs in Hong Kong.
In Australia too, the equity markets performed
well, with the S&P ASX rising 5.1% amidst
positive economic (GDP rose 1.3% in Q2 2005)
and corporate earnings data and strong commodity
prices. These robust figures were also reflected
in a cheapening of bond prices, with 10-year
bond yields rising from 5.05% to 5.36% over
Taiwan continues to be the worst performing
economy in the region, with a problem-riddled
banking sector and a capital intensive technology
sector. Furthermore, Taiwan may also be
suffering from a fall in Chinese imports
of its finished goods, as China builds up
its own domestic capabilities.
Hedge Fund Performance
At 2.8%, Asian hedge funds allocating to
the equity long/short strategy posted the
best returns for September. In addition
to the rising equity markets, these funds
were further assisted by their traditional
long-bias as compared to hedge funds allocating
to other regions. Impressive gains were
made in the hospitality and industrials
sectors in India and the banking sector
Convertible arbitrage funds in Asia too
were sensitive to the volatility in the
global energy markets, (Japan being the
exception for reasons elsewhere stated).
Consequently, they had a bad rap in September,
returning negative 0.5%.
Going forward, Taiwan has shown a slow recovery
during the month and is expected to continue
on that path in the coming month. Activity
in the Asian credit markets is also set
for a rise in the coming months, with new
issuance in high yield instruments in the
pipeline. Overall, the key Asian regions
of Korea, China and India continue to hold
opportunities for hedge funds for the rest
of the year, although the immediate months
may see some profit-taking following the
all-time highs in some of the equity markets,
such as those in India and Korea.
Latin American markets had a terrific month
in September, benefiting from a combination
of strong fundamental growth, healthy
trade and fiscal conditions and technical
factors. The MSCI EMF Latin America Index
rose a spectacular 15.5%, driven primarily
by oil and energy-related stock rallies.
The Brazilian markets rose sharply in September
on the combined strength of a cut in interest
rates and strong commodity prices. The corruption
scandal and the ensuing political crisis
show signs of fizzling out, a trend already
seen in August in the indifference of institutional
investors. Brazil has even managed to make
an international bond issue it's
first denominated in real and equivalent
to US$1.5 billion.
In Argentina, economic data has been very
positive with GDP growth of 9% year-on-year
exceeding market estimates. However, inflationary
pressures are on the rise and several sectors
of the economy are reaching full capacity.
Mexico bounced back from its weak performance
in August, also driven by rate cuts and
positive economic data.
Hedge Fund Performance
While long/short funds both onshore
and offshore took handsome gains
of over 6% each amidst soaring equity markets,
one glaring contrast between on and offshore
funds is in the performance of macro funds.
For the latter, it was among the best-performing
strategies for the month (+4.5%), whereas
for the former, they were the worst-performing
strategy, posting negative returns of close
One possible explanation is that the Latin
American markets offer good onshore/offshore
arbitrage opportunities for hedge funds,
and they have recently witness strong surges
in liquidity. To take the example of the
Brazilian real, there has been a surge in
capital flow into offshore hedge funds in
September, owing to investors interested
in taking long positions in the real and
short positions in offshore currencies.
As a consequence, the Brazilian real has
strengthened over the month. This could
have caught the onshore funds on the wrong
side of the bargain.
Short-term market sentiment on emerging
markets will continue to be bullish, and
September's performance numbers can only
reinforce this sentiment. The markets will
see continued liquidity, with more foreign
investors wanting a share of the emerging
market return pie.
Despite the seemingly unfettered performance
of emerging markets and Japan (weathering
as they did, the twin hurricanes and rising
oil prices), these very same factors could
make the anticipated interest rate hikes
in the US that much more pronouncedly felt
for the US consumer. Inflationary pressures
are looming on several of the regional investment
horizons, and hold potential negative repercussions
for global equities as well as global growth
trends. Nevertheless, in the months to come,
hedge funds can expect several pockets of
opportunities, as some of the regional bull
runs are sustainable by market fundamentals.
Also merger activity is on the rise, with
more than 25 multi-billion dollar deals
announced during September alone.
1Based on 95%
of the NAV data for September received to
date (27 October 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