The Eurekahedge Hedge Fund Index was up a modest 0.6%1 for the month of March. Market movements during the first half of March were very much a continuation of those towards end-February, with heightened volatility and investor uncertainty. The markets, however, stabilised mid-month, as valuations became attractive once again and as the FOMC meeting announced that the target federal funds rate would remain unchanged (with a later clarification that inflationary risks remain its main focus). For instance, the MSCI World (Equity) Index shed nearly 3% in the month’s first three days of trading, but eventually closed the month up 1.6%.
Choppy US markets translated to a marginally positive month for North American hedge funds on average (+0.4%). European hedge funds (+1.5%), on the other hand, benefited from a stronger recovery owing to robust Eurozone economic data and a hawkish European Central Bank (ECB). Emerging markets too finished the month strongly up (the MSCI Emerging Markets Index rose 4% during the month) and so did funds allocating to emerging markets; Asian managers were up 1.8% for the month, while Latin American managers gained 1.1%, on average. This is depicted in the graph below comparing regional hedge fund performance for the first quarter of 2007.
Global Market Review
March began with a continued sell-off in all major equity markets. By 14 March, the S&P 500, the DJ Euro Stoxx 50 and the Nikkei 225 were all down 3-4% each. The resulting attractiveness of valuations all around and continued aggressive M&A activity during the second half of March, lent support to a mid-month upward reversal in equities.
Global bond prices rallied strongly early in the month (owing to lowered risk appetites), but eventually moved lower for March, as risk aversion as well as expectations of lower interest rates, diminished. While the FOMC meeting announced that the target federal funds rate would remain unchanged, a later clarification from the Federal Reserve that inflationary risks remain its main focus pushed future yield expectations higher.
Energy markets too had a difficult month as crude oil prices dropped to US$56 during the first half of the month (reflecting rising recessionary fears and the attendant drop in demand) but rose sharply to US$66 (on the back of escalating geo-political tensions in the Middle East).
And lastly, in the currency markets, the USD weakened on mixed economic data while higher-yielding currencies rallied strongly. The euro, in particular, strengthened to reach multi-year highs on the back of positive economic data emanating from the Eurozone and hawkish comments from the ECB. Recovery in the Japanese yen, however, could not be sustained, given the return of more stable market conditions, falling US bond prices and a resurgence of yen-funded carry trade transactions.
In light of the above, CTA and directional macro strategies had yet another difficult month (returning -1.9% and -0.1% respectively), while the best returns came from opportunistic, arbitrage and pair-trading strategies, as highlighted in the graph below.
The Eurekahedge North American Hedge Fund Index had a relatively flat month (+0.4%) in March, masking modest gains made across most strategies. Distressed debt was the best performing strategy for the month (+2.1%) as the high yield market continued to be resilient to negative economic data (concerns about the housing and sub-prime mortgage markets, for instance). Managers have been able to capitalise on mis-priced risk across a variety of asset classes, as well as new deal flow.
Relative value (+1.1%) and arbitrage (+0.6%) players benefited from all-round spike in volatility, while equity long/short managers (+0.7%) profited from both the long and short books, given the month’s equity market swings.
Aggressive M&A activity towards the latter half of the month, with attractive valuations and bottom-trolling private equity firms, afforded profitable plays to event-driven managers (+0.7%).
And lastly, fixed income managers were up 0.6% as well, with profitable bets on the flattening yield curve as clarifications on the mid-month FOMC release pushed future yield expectations higher, and mixed economic data (payrolls were in line with expectations while concerns remain about the housing and sub-prime mortgage markets) led to rising yields on the short-end; 2-year US Treasury Note yields rose 3 bps, while 10-year yields dropped 8 bps and 30-year bonds fell by 16 bps.
Furthermore, new issuance activity in the convertibles space continued on at a brisk pace (35 new deals raising US$16 billion, came to market during the month), proving beneficial to convertible arbitrageurs.
Eurekahedge North American Hedge Fund Index
The Eurekahedge European Hedge Fund Index posted healthy returns for the month (+1.5%), with broad-based gains across most strategies, as the markets responded strongly to positive economic data and an expected rate hike (by 25 bps) by the ECB.
The best returns for the month came from event-driven managers (+2.6%) as a host of M&A plays presented themselves during the month, primarily driven by private equity firms and industrial consolidation. For instance, in the utilities sector, bidding wars for the Spanish utility company Endesa by three other companies (Enel, E.ON and Acciona) concluded in a three-party agreement.
This heightened corporate activity has, in turn, lent support to equity prices, and so did positive earnings data and earnings expectations. Equity markets in the region recovered quickly as a result, and this helped long/short managers (+1.6%) recover any losses incurred early in the month.
CTA funds were another top performer for the month (+2.2%), as the sharp rise in crude prices during the month underpinned renewed enthusiasm for exploration and production companies, and in particular, the more leveraged oil service sector. Fundamental factors such as expectations of a pick-up in demand during the latter half of the year also helped.
CTA / Managed Futures
Eurekahedge European Hedge Fund Index
The Eurekahedge Japan Hedge Fund Index had a lacklustre month (-0.5%) as equities displayed continued weakness throughout the month, with bond markets largely flat and economic data mixed (strong capital spending and weaker-than-expected consumer spending).
Japanese equities followed a similar, if slightly delayed, path compared to equity markets elsewhere, as the rebound towards month-end fell short of recovering the losses made early in the month. The mid- and small-cap markets underperformed their large-cap peers; the Nikkei 225 declined 1.8% for the month, while the Nikkei Jasdaq shed 2.5%. As a result, Japanese equity long/short managers closed the month down 0.8%.
Consequently, relative value and multi-strategy funds also remained largely flat during the month.
The one exception to the trend were event-driven strategies, which posted impressive returns at 6.6%. The month witnessed several profitable merger arbitrage plays such as GIGAS, SYSMEX and NEXTCOM.
Asia ex-Japan was the best-performing region for the month, with the Eurekahedge Asia ex-Japan Hedge Fund Index up an impressive 1.8%, and most strategies returning upwards of 1.5%. Asian markets bottomed out in the first few days of March but steadily gained back lost ground. After the initial sell-off, more discerning investing led to rallying markets in Taiwan, Korea and Indonesia, to name a few. Most Asian economies continue to be fundamentally strong.
In China, optimistic market sentiment toward the month’s end was further supported by higher-than-expected annual corporate earnings results. Strong domestic liquidity more than offset the negative impact of a hike in interest rates, as the Shanghai A-Share Index rose a stellar 10.2%.
Australian markets too recovered on strong earnings momentum, with equities rising 5.5% on average.
Volatility in the Indian markets, on the other hand, was exacerbated by the government’s steps to reign in inflation (controls on cement prices in early March and an unexpected rate hike on the last trading day of the month). The global turnaround later in the month could only marginally recover these losses, as the BSE Sensex rose 1% for March.
In terms of hedge fund performance, given the positive earnings data, attractive valuations and resurgent interest in high-risk assets, the month was very profitable for equity-focused strategies such as long/short and event driven.
That said, distressed debt was the best-performing strategy in the region (+2.2%), as Asia ex-Japan fixed income markets rallied in March. The upturn in regional equities spurred investors into taking on riskier assets such as high-yield corporate and sovereign bonds. This improving market sentiment drove new issuance as US$3.04 billion in new issues came to the market.
Eurekahedge Asia ex-Japan Hedge Fund Index
The Eurekahedge Latin American Hedge Fund Index rose a healthy 1.1% for March, as the region’s markets witnessed a sharp recovery towards the latter half of the month. The MSCI Latin America Equity Index was up 6.9% for the month.
Latin American equity prices in March were largely governed by external factors, with uncertainty regarding global growth and US interest rate expectations raising market volatility, as well as better-than-expected economic readings from Europe fuelling the search for higher-yielding assets and prompting a market rebound. This robust recovery helped the region’s directional macro (+2.7%) and equity long/short (+1.6%) funds post solid gains for the month.
The interest rate markets performed well too, with fixed income managers (+1%) benefiting from long rates positions in Colombia and Brazil.
Eurekahedge Latin American Hedge Fund Index
To summarise, we continue to believe that the end-February-early-March price movement was a healthy short-term correction, and not a reassessment of any market fundamentals. Macroeconomic data support a scenario of slower global growth, but not recession; while the US continues to show some signs of weakness, the rest of the world continues to show strong growth. Risk appetites have returned from non-existent to more normal levels, while valuations look more attractive. Merger activity continues at a heightened pace.
Given this favourable scenario, we expect hedge fund performance in the coming months to remain healthy, particularly in equity-based and opportunistic strategies.
1Based on 60% of the funds reporting their Mar 2007 returns as at 16 Apr 2007.
2The Eurekahedge Japan Hedge Fund Index is a Octarate 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 investment mandate.