Hedge funds reined in their losses in July, as global financial markets witnessed sharp declines and reversals across major asset classes; the Dow Jones-AIG Commodity Index fell 12%, while the MSCI World Index, after shedding 5.6% intra-month, finished the month down 2.5%. By comparison, the Eurekahedge Hedge Fund Index declined by a relatively modest 2.5%1, on the month.
July saw most regional mandates finish in the red. Managers allocating to North America, Latin America, Asia ex-Japan and Japan were all down between 1% and 1.8%, being negatively impacted by the sudden decline in commodity prices across the board. Furthermore, the bounceback in equities at mid-month led managers to unwind their long commodity and short equity positions, resulting in losses during the month.
Managers in Europe were also affected by the marked difference in market movements seen during the two halves of the month. However, their Eastern Europe & Russia-investing counterparts were down a notable 10.6% in July, largely because the regionís equity markets (-10.8%) were hit by the sharp decline in crude-oil prices. This goes some way in explaining the 3.5% fall in the Eurekahedge European Hedge Fund Index.
The chart below illustrates the current-month, previous-month and year-to-date returns across the different regional mandates.
Eurekahedge Performance Indices - 2008 YTD (Regions)
July was another rough month in the underlying markets, which saw contrasting movements across the different asset classes during the month.
Global equity markets (as per the MSCI World Index), which treaded negative till July 15, rebounded around mid-month and finished the month down 2.5%. This (rebound) was partly an outcome of the Fedís intervention to save some large distressed financial firms in the US. Additionally, receding inflationary pressures in the West (owing to a sharp correction in commodity prices) and 2Q earnings data being in line with expectations, if not better, also lent some support to the equity markets during the second half of the month.
In terms of regional equity indices, the S&P 500 lost 1% on a monthly basis, while losses in European indices were more pronounced (FTSE 100 shed 3.8%) owing to domestic growth concerns. Japanís Nikkei shed 0.8%, as the outperformance of currency-sensitive sectors (owing to a stronger US dollar) more than offset the underperformance of commodity-related sectors.
Emerging market equities saw mixed returns. Brazil and Russia (-8.5% and -13% respectively) were affected by the sharp correction in crude prices, among other things. Chinese stocks rose 1.5%, amid growing retail sales and a decent trade surplus in June, while Indiaís S&P CNX Nifty rose 7.2%, partly due to political factors.
The fixed income markets saw bond prices close higher on the month, as concerns on economic growth and falling energy prices worked towards curtailing inflationary pressures. The Bunds, which rose 2% on a monthly basis, outperformed both US Treasuries and JBGs, during the month.
The commodity markets saw crude oil, among other commodities, hit yet another record high in July. However, the second half of the month witnessed sharp corrections, bringing the Dow Jones-AIG Commodity Index down 12% on the month. Crude prices fell 11.4% during the month, amid concerns on falling demand for the commodity. A bunch of other commodities (particularly agricultural) also saw a price decline owing to increased inventories and/or production, coupled with lower demand. Some precious metals, such as platinum (-15%), were also down owing to a stronger dollar and slower global economic growth.
The currency markets saw the US dollar bounced back from its intra-month lows, against most major currencies, partly due to a sharp downturn in commodity prices. It strengthened 1% against the euro, owing to signs of an economic slowdown in Europe, and rose 1.6% against the yen, as the latter weakened while risk aversion declined.
The chart below shows the current-month, previous-month and year-to-date returns across different investment strategies.
Eurekahedge Performance Indices - 2008 YTD (Strategies)
A) Arbitrage and Relative Value
The Eurekahedge Arbitrage and Relative Value indices were down 0.3% and 0.6% respectively, in July. While managers of the strategies were negatively impacted by, among other things, some redemptions and increased margin requirements; the volatility across asset classes helped them exploit inefficiencies in the underlying markets.
In North America, arbitrageurs finished the month down 0.5% while their relative value-investing counterparts ended the month relatively flat (-0.2%). A significant portion of the monthís losses for managers in the region came as a result of further deterioration in the convertible market. Participants in the market experienced liquidity-driven selling pressures, which resulted in further down-pricing of securities, thereby adversely affecting managersí books. However, some managers offset a portion of these losses by taking long positions in names that were likely to announce impressive 2Q earnings, thus cashing in on gains once they did.
Arbitrageurs in Europe (-0.2%) had a flat to negative month, as unwinding of long financials and short commodity positions towards the latter part of the month negatively impacted managersí books. However, a mix of both positive and negative economic data around the region led to an increase in implied volatilities across some regional fixed income markets, which benefited allocations to the region.
Asia ex-Japan focused relative value managers generally had a flat to positive month. The regionís index, however, shed 2.9% as one Australia-investing constituent fund turned in losses of over 7% in July. On the whole, managers benefited from the movements in some major regional equity markets, with stocks in Hong Kong (2.9%), China (1.5%) and India (7.2%) rebounding strongly during the second half of the month. On the other hand, long exposure to other markets such as Taiwan, Korea, Thailand, among others, proved loss-making.
Arbitrage and Relative Value (July-08 and 2008-YTD Returns)
B) Long/Short Equities and Event-driven
The Eurekahedge Long/Short Equities Hedge Fund Index declined 2.6% in July, mainly because a number of managers of the strategy were not positioned in anticipation of the sharp and sudden up-turn in global equity markets. After losing 5.6% around mid-month, the MSCI World Index changed course to close the month down only 2.5%.
In terms of regional mandates, all regions registered losses of over 1%, during the month. The largest contributors to the monthís losses were managers allocating to Europe (-3.7%). Generally, the returns of European allocations were in line with the global average. However, the regionís average was dragged down by managers allocating to Eastern Europe & Russia (-11.2%), as all reporting funds for the region posted negative returns. Across the rest of Europe, longs in financials and shorts in energy-related stocks proved profitable to managers who had anticipated the sectoral movements in the markets, during the second half of the month.
Latin American long/short managers were down 1.9%, as further deterioration in inflation expectations, a sharp decline in commodity prices, and distress across global financial markets negatively impacted the regionís stock markets. While exposure to equities in Argentina and Brazil proved loss-making (-19.3% and -10.5% respectively), managers allocating to countries such as Chile made some decent gains. Stocks in Chile were up 6%, with the electricity sector leading the way; the sector benefited from expectations of higher production, on account of increased rainfall.
Allocations to both Japan and Asia ex-Japan were down 1.5% each, against a decline of 3.4% and 3.1% respectively in MSCIís indices for the regions. In Asia ex-Japan, strong equity market reversals in Hong Kong, China and India (up 2.9%, 1.5% and 7.2% respectively, at month end), afforded regional managers with decent opportunities to offset a portion of their losses suffered during the first half of the month. However, single-country focused managers allocating to Taiwan, Korea and Australia/New Zealand were hit by moderate to sharp negative returns across the regionsí equity markets in July. Allocations to Japan benefited from exposure to financials and most currency-sensitive sectors, while investments across commodity-related stocks proved loss-making, on the month.
North American managers (-1.1%) posted the least negative returns for the strategy. Some regional managers who had positioned their portfolios in anticipation of a fall in commodity prices (due to unreasonably high costs and a lower shift in global demand) finished the month in positive territory. Some others managed to unwind their short financials and long commodity trades just in time to get away with flat to marginally negative returns, while many of the rest were hit by intra-month change in sectoral movements.
The Eurekahedge Event Driven Hedge Fund Index shed 2.8% in July, as event-driven managers were also largely affected by the volatility in the equity markets throughout the month. North American managers (-0.1%) finished the month flat, as some corporate activity gave market players decent opportunities to offset their losses suffered due to harsh movements in the broader markets. The closing of the prolonged Clear Channel Communications deal, during the month, is a case in point.
The European Event Driven index shed 6.1% during the month. Although all constituent funds (that have reported to-date) finished the month in negative territory, the index was negatively skewed by two of them, which turned in losses of about 12% and 17% respectively. On the whole, managers were faced with difficult conditions in the underlying markets, as some negative economic data, wide fluctuations in commodity prices and sudden shifts in investor sentiment (albeit for the near term) rendered the equity markets highly volatile.
Event-driven allocations to Asia ex-Japan finished the month down 1%, while those in Japan turned in flat returns (0.01%). On the whole, broader geographical mandates and activist funds turned in losses during the month. However, single-country focused allocations proved relatively profitable, as managers benefited from some special situations in the region, such as the higher takeover bid for Just Group (an Australian clothing retailer), for instance.
Event-driven managers in Latin America (0.9%) were the only ones to record healthy gains in July, despite sharp downturns in regional equity markets. Pair trades in the mining and telecom sectors proved rewarding for managers in the region, while exposure to oil, petrochemicals and financials sectors offset a portion of their gains.
Long/Short and Event-driven (July-08 and 2008-YTD Returns)
C) Fixed Income and Distressed Debt
The Eurekahedge Fixed Income Hedge Fund Index recorded a loss of 0.5% this July, amid some volatility in the fixed income markets during the month. A sharp fall in commodity prices (the Reuters CRB Index fell 7.9%) went some way in curtailing inflationary pressures and in turn favouring bond markets, particularly through the second half of the month.
In terms of regional mandates, North American managers (0.4%) recorded modest returns, amid declining treasury yields during the latter half of the month. The yield on the 90-day T-bill was down 8bps, while that on the US 10-year T-note remained unchanged on a monthly basis, after seeing an intra-month increase of 17bps.
European managers were down 1%. Signs of an economic slowdown suggest that the region may not see further monetary tightening in the very near future. This resulted in some volatility in interest rates, bringing them down, thereby negatively impacting fixed income managers in the region. In Latin America (0.9%), some tightening at the long end of Brazilís local yield curve (owing to a 75bps rate increase) afforded managers with some trading opportunities. Managers allocating to Asia ex-Japan (0.3%) finished the month relatively flat, but in positive territory.
Distressed debt managers were down 0.5% on a monthly basis, amid wider credit spreads and further deterioration in the high yield markets. The announcement by Merrill Lynch of a sale of over US$30 billion worth of collateralised debt obligations, at a discount of over 75%, also brought down the prices of such instruments.
Against such movements, North American managers finished the month flat (0.1%). Losses from trading high yield debt and mortgage-backed securities were offset by gains from, among other things, trades in other asset-backed securities during the month. Asia-focused managers were up 0.7%, with investments in non-performing loans across Greater China, among other things, proving rewarding.
Fixed Income and Distressed Debt (July-08 and 2008-YTD Returns)
D) CTA/Managed Futures and Macro
CTA/Managed Futures hedge funds (-4.2%) had a rough month in July, partly due to a sharp correction in commodity prices during the month. Crude oil prices, which made yet another record high (around US$147/barrel) in July, saw the biggest daily drop in 17 years amid concerns on the demand for the commodity. On the whole, crude oil prices fell 11.4% on a monthly basis, with some precious metals, softs and grains also recording double-digit declines, during the month.
Sudden movements in the currency markets also went some way in impacting the performance of managers of the strategy. For instance, the US dollar rebounded from its record low against the euro, on the back of lower commodity prices and signs of a slowdown in Europe. Likewise, the yen started the month strong against the US dollar, but weakened considerably as risk aversion declined into the month. The US dollar finished the month up 1% and 1.6% against the euro and the yen respectively.
Macro managers were down 1.2% during the month, as a good portion of the losses they suffered from movements in the currency and commodity markets were offset by some gains from other asset classes (namely equities, and to some extent, fixed income). On the whole, managers who re-positioned their portfolios in anticipation of a fall in commodities (due to extremely high and unjustified prices, and chances of a consequent decline in demand) recorded positive returns during the month.
CTA/Managed Futures and Macro (July-08 and 2008-YTD Returns)
The Eurekahedge Multi-Strategy Hedge Fund Index posted a loss of 1.9% in July, on the back of heightened volatility across asset classes in the underlying markets. In terms of regional mandates, North American and European managers recorded the lowest returns (-3% and -3.1% respectively). Returns for the European region, however, were significantly affected by loss-making Eastern Europe-focused managers, as regional equities (-10.8%) fell considerably on the back of falling crude oil prices. On the whole, managers across both North America and Europe were down largely owing to the sudden and unanticipated movements in the commodity and equity markets. Those that entered July with long commodity and short financial positions suffered the biggest losses.
Multi-strategy players allocating to Asia ex-Japan (-0.5%) had a relatively decent month, as gains from exposure to equities in Hong Kong, China and India, among some other regions, helped to offset losses suffered from exposure to other markets in the region. Furthermore, appreciation in the Chinese renminbi (0.3%) and the Indian rupee (1%) against the US dollar afforded currency-investing managers with some opportunities during the month. Japanese allocations were down 1.1% in July, as sudden movements in currencies took a toll on the performance of multi-strategy managers in the region; the yen fell 1.6% against the US dollar, despite a strong start in July.
Latin American multi-strategy (-0.5%) managers also had a rather decent month, despite a sharp downturn across equities in the region. This is because managers in the region were afforded with healthy opportunities in the currency market; the Columbian peso and the Brazilian real strengthened 6.2% and 2.3% respectively, against the dollar.
After an eventful month in July, which saw trend reversals across some key asset classes, August has come across as a fairly positive month so far. Some of the major Western equity markets are faring pretty well (despite some volatility) month-to-date, with commodity prices continuing their downward slide and the US dollar gaining strength against some major currencies. Not only has this strengthened investor sentiment to some extent, it has also translated into a marginal increase in risk appetite. Furthermore, the notable correction in commodity prices has gone some way in reducing inflationary pressures, thereby also changing the interest rate outlook of several market participants as well as central banks.
As far as troubles in the US are concerned, though they seem to be far from over, the macro-economic picture looks a lot better now. Latest reports state that the US trade deficit unexpectedly improved in June, falling by 10.3% to US$39.1 billion Ė the lowest level seen since December 2001. In July, data pointed towards an increase in the number of home sale agreements signed in the US, and August (to-date) has seen an improvement in US consumer confidence data, partly owing to falling gasoline prices. We anticipate such news to translate into a further increase in risk appetites over the near term and perhaps into fresh inflows into the hedge fund industry over months to come.
We continue to remain fairly optimistic about hedge fund performance for the rest of this year and beyond, as we anticipate the near- to medium-term volatility across asset classes to translate into decent opportunities for managers employing short-term trading. Furthermore, the upward trend in equities could indicate healthy gains for value-investing equity managers on the long side, while a further correction in commodities can mean decent opportunities in commodity-related stocks on the short side. The decline in the prices of commodities, many of which are still considered to be relatively overvalued, would also afford CTAs and directional macro strategies with lucrative opportunities on the short side.
1 Based on 51.41% of the funds reporting their July 2008 returns as at 14 August 2008.