After registering impressive gains in February, hedge funds faced a difficult month in March against the backdrop of persistent concerns on the slowing of global growth and the likelihood of a recession in the US. The composite Eurekahedge Hedge Fund Index shed 1.9%1. Volatility across the underlying markets, particularly prior to the Fed’s 75 bps rate cut on 18 March, coupled with a weak state of the credit markets, were among the factors responsible for the month’s losses. The Bear Stearns collapse and its subsequent takeover by JPMorgan (with assistance from the Federal Reserve), along with additional write-downs by major global investment banks, further weighed on the markets.
In terms of regional mandates, North American hedge funds (-1.1%) were the least negative, as decent gains from bets against the US dollar and short positions across equities, among other things, helped offset some of the losses suffered from other allocations during the month. Fixed income and commodity trades also accounted for some gains across the region. Managers, however, suffered losses from long exposure to high-yield debt (as credit spreads widened significantly) and equities.
Europe-focused hedge funds were down 1.6%, as the turmoil in the US economy, the weakness across the European credit markets and inflation-centred concerns across Europe, largely rendered the trading environment unfavourable. Additionally, further strengthening in the euro went some way in acting like a drag on earnings in the region (although some managers did largely benefit from shorting the US dollar against it).
Asian managers lost 3.3% during March, with the Asia ex-Japan component of the regional index shedding 3.9%. Managers investing in the region (Asia ex-Japan) were largely impacted by the drawdown across equities in Hong Kong, China and India, among other countries. However, positions in markets such as Korea and Taiwan helped in offsetting some losses during the month.
Japan-investing funds marginally outperformed their Asia ex-Japan-focused counterparts, registering losses averaging 3.3% during the month. Managers holding long positions in sectors such as materials, capital goods and technology, among others, suffered losses on the month. Long exposure to export-related sectors (owing to the notable strengthening of the yen) also resulted in some losses.
Latin American managers, after an impressive month in February, were down 3% in March, despite decent gains posted by equity markets in Argentina, Chile and Mexico for the month. Losses across the region, which can partly be attributed to the decline in commodity prices across the board (during the second half of the month), weighed on the regional markets. The declines in Brazilian equities also accounted for a portion of the losses suffered by managers investing in the region.
The chart below illustrates the present month (March 2008), previous month (February 2008) and year-to-date returns across the different geographical mandates.
Global Market Review
In underlying markets, equities continued to remain volatile throughout March. The MSCI World Index lost 1.3% during the month. In terms of regions, the developed markets fared better than their emerging market counterparts. The S&P 500 and the FTSE shed 0.6% and 3.1% respectively. Japan, however, took a hit, as export-related sectors (owing to the sharp strengthening of the yen), among some others, fared poorly; the Topix was down 8.4% at month-end.
In the emerging markets, MSCI’s Chinese and Indian equity indices recorded double-digit declines for the month, being negatively impacted by inflation concerns in their respective countries. In China, the widespread anticipation of a further tightening of money supply spooked regional equities, while in India, domestic factors (such as some implications of the Union Budget for 2008-2009), among other things, caused domestic investors to turn net sellers during the month.
However, equities in Korea and Taiwan finished the month in positive territory; the weaker Korean won benefited the former, while the latter continued its election rally, on expectation of the new president to improve the domestic economy. Latin American equities were down 3.6%, partly owing to the sell-off across commodities, during the month.
Fixed income markets fared well during the first half of the month, on the back of high investor risk aversion. However, prices of instruments declined towards the month-end as central banks provided support to the markets by infusing liquidity. At month-end, yields on the US 10-year T-note and the 90-day T-bill were down 0.1 and 0.5 percentage points respectively. In Japan, the 10-year bond rallied strongly, with the yield falling to 1.26% intra-month.
The commodity markets, after rallying through the first half of the month, sold off aggressively against the backdrop of high risk aversion. Crude oil was among some of the commodities (including some agricultural commodities) to have touched record highs during the first half of March, but closed the month comfortably above US$100.
In the currency markets, the US dollar continued its free fall, as the Fed announced another rate cut in March. It touched a record low against the euro, and reached its lowest price in over a decade, against the yen, having depreciated by 3.9% against both.
The chart below illustrates the returns across the different strategic mandates globally.
Performance of Strategic Mandates
A) Arbitrage and Relative Value
The Eurekahedge Arbitrage and Relative Value Hedge Fund indices ended March with returns averaging -1.4 and -2.2 percentage points.
North American arbitrageurs and relative value managers were down 1.2% and 1.1% respectively, against a backdrop of de-leveraging across the financial system. Convertible arbitrage trading proved loss-making during the month, since weak economic data coupled with unfavourable credit market conditions caused convertible paper to cheapen. Furthermore, a number of managers were also forced into selling their holdings, in order to meet investor redemptions and margin calls.
In Europe, however, arbitrage managers registered flat to negative returns (-0.3%), while relative value players were down 1.1%, partly owing to the high intra-month volatility across equities, particularly in the financial sector.
Asia ex-Japan focused relative value managers posted the largest monthly declines, averaging 8.3%, as the strategy’s exposure to the Australia/New Zealand markets proved unprofitable.
B) Long/Short Equities and Event-driven
Long/short managers in North America and Europe registered losses averaging 1.3% and 1.5% respectively. In North America, the financial sector came under stress on the back of the collapse of Bear Stearns. On the whole, most long positions resulted in losses during the month, while short positions helped in protecting capital to some extent. European managers, against a general slowdown across the region and amid large investment banks increasing their write-downs from the US subprime mess, also suffered losses from many of their long positions across the financial sector, among others.
Managers investing in Asia ex-Japan were down 4.7%, as the equity markets in Hong Kong, China, India and Australia finished the month negative; several trades across these markets translated into losses. Allocations to Taiwan, however, resulted in healthy gains, owing to decent returns of the domestic stock market. Japanese managers were down 1.7%, as long exposure to sectors such as technology, among other export-related sectors, proved unprofitable. However managers offset some of their losses with gains from short positions in sectors such as consumer durables and materials.
Latin American long/short managers posted losses averaging 3.9%. This can largely be attributed to the decline in commodity prices during the month, which impacted the performance of equities to a certain extent. The MSCI EM Latin America Index lost 3.6% in March.
The Eurekahedge Event Driven Hedge Fund Index declined by 2% on the month, with volatility in equities turning out unfavourable for managers. Regions with higher drawdowns in equities, such as Asia ex-Japan, posted larger declines during the month.
Transactions – such as the acquisition of Clear Channel Communications, among others – having failed to reach a stage of closure, worked against the managers of the strategy. However, events like the record-breaking US$17 billion Visa IPO that took place in March, did afford some managers with healthy opportunities.
C) Fixed Income and Distressed Debt
Fixed income managers registered losses averaging 0.8% on the month, while distressed debt players, against a backdrop of wider credit spreads across the board, turned in returns of -1.1%.
Fixed income managers in North America registered average returns (-0.8%), as instruments related to the strategy – particularly treasuries – corrected significantly towards the month-end, after having fared reasonably well during the month. The US 3-month T-bill suffered its biggest weekly decline in over two decades, during the latter part of the month. Distressed debt managers lost 1.3% in March, partly owing to, among other things, the poor performance of the high-yield market.
European fixed income funds were down 2.5% on the month, amid further stress across regional money markets (as the Euro Interbank Offered Rate rose 35 bps), while their Asia ex-Japan focused counterparts finished the month down 1.3%.
Latin American fixed income managers turned in gains of 0.7%, despite the local yield curve (particularly in Brazil) having performed poorly on the month. These gains can partly be attributed to the positive impact of the inflation-curbing measures of the Brazilian government on domestic interest rates.
D) CTA/Managed Futures and Macro
CTA was the only strategy to finish the month of March flat (-0.1%) and with positive returns across all regional mandates. Macro managers, however, registered returns averaging -2%.
North American CTAs (1.2%) made healthy gains from rallying commodities during the first half of the month, and from shorting the free-falling US dollar against currencies such as the euro, the Swiss franc and the yen. Such movements across the currency and commodity markets also went in favour of global-mandated macro managers, with exposure to North America.
Europe-focused CTAs (2.2%) registered even better returns, benefiting partly from the movements across the currency markets (the euro gained 3.9% against the US dollar). Trading crude oil futures also proved profitable for managers allocating to the region. Global macro managers investing in the region were also afforded with opportunities (especially on the short-side) in the equity markets.
In Asia, the strengthening of the Chinese yuan (1.4%) and the yen (3.9%) against the US dollar, and the 2% depreciation in the Australian dollar, among other things, posed decent trading opportunities for CTAs and global macro managers.
The Eurekahedge Multi-Strategy Hedge Fund Index lost 2.1% during March, with Asia ex-Japan (-2.4%) registering the largest losses and Japan (0.5%) being the only positive contributor to the strategy.
Multi-strategy managers in Asia ex-Japan were impacted the most by the equity drawdowns, coupled with intra-month volatility, in Hong Kong, China and India. They were also posed with decent opportunities across the domestic currency markets, with the Chinese yuan and the Australian dollar moving in opposite directions, against the US dollar.
Japanese managers were up 0.5%, as short exposure to equities, coupled with some select long-bets proved profitable, and more than offset losses suffered from other long positions in equities.
Multi-strategy managers in North America and Europe ended the month negative, as most trading styles (with the notable exception of CTAs) across both the regions finished in negative territory. In a nutshell, managers made decent gains from shorts in the US dollar and equities, while long exposure to equities and a sell-off across commodities, in the second half of the month, eroded gains.
March was another volatile month for most asset classes, amid an environment of heightened investor risk aversion, inflation concerns across the board, liquidity issues taking a toll on financial institutions, and large firms reporting further write-downs resulting from the meltdown of the US subprime mortgage market.
On the whole, however, our outlook for hedge fund performance remains positive, based on several factors. As we mentioned in the previous month’s commentary, valuations across most equity markets are considerably lower now, which, coupled with the persistent volatility, play a part in affording managers with lucrative opportunities.
Furthermore, corrections seen across commodity markets in March and market players having mixed near-term outlooks for commodities, could largely bring about short-term pricing inefficiencies and work in favour of some managers. Additionally, with many early reporting firms having declared healthy (in line with expectations, if not better) earnings for the first quarter, managers could look forward to improved investor sentiment, and hopefully, healthier risk appetites.
As for the US, most market participants have already given in to the fact that a recession in the US economy is imminent. However, the question that still remains is, how much more of the slowdown phase is yet to be seen, and more importantly, how much of an impact it will have on the global economy. The Fed has been acting aggressively in order to curb the extent of the slowdown. It has done so by lowering interest rates by a further 75 bps in March. It has also shown its concern by mediating the fire sale of Bear Stearns to its rival – JPMorgan Chase. Besides this, present market movements and expectations of market participants suggest that one could look forward to another rate cut of at least 25 bps, if not 50, in the next FOMC meeting, on 30 April.
1 Based on 51.62% of the NAV for March 2008 as at 14 Apr 2008.