Hedge funds had another strong month in May, as the Eurekahedge Hedge Fund Index rose 2%1 during the month, despite persistent inflation concerns weighing on the markets and on investor sentiment. Managers made good gains from equities, which recorded mixed returns across different regions (the MSCI World Index rose 1.1%), and from commodities (as commodities such as crude oil and gas, among others, rallied strongly) during the month. A marginally stronger US dollar (against some major currencies) also translated into some gains, over May.
In terms of regional mandates, European managers recorded the best returns, returning 2.7% on the month. Eastern European and Russian managers were the main contributors to returns across Europe; the Eurekahedge Eastern Europe & Russia Hedge Fund Index returned 5.7% during the month (partly because one constituent fund positively skewed the region's average considerably). As for managers in other European regions, they have made healthy gains from commodities, as well as from long and short exposure to regions equities (the MSCI Europe Index lost 0.5%).
Latin American managers (2.5%) benefited from their exposure to Brazil, as the market received a strong boost from Fitch's move of upgrading Brazil to investment grade, following a similar move by S&P's in April. On the whole, double-digit gains across equities in Brazil and Argentina, coupled with the strengthening of domestic currencies against the US dollar, and soaring commodity prices afforded managers in the regions with healthy opportunities throughout most of May.
North American managers were also up a solid 2.5% in May, despite notably slow growth in the US economy and a stream of rather discouraging economic news on inflation and consumer spending, among other things. Managers in the region profited from both long and short exposure to regional equities, and from currencies (shorting the yen and euro against the marginally stronger US dollar) and commodities.
Asian managers, particularly those allocating to Asia ex-Japan, were among the worst performers in May; the Eurekahedge Asia ex-Japan Hedge Fund Index finished the month flat to negative (-0.1%). This was mainly because major equity markets such as those in China and India saw significant losses on a monthly basis, owing to factors such as natural disasters (a devastating earthquake in China) and concerns on heightened inflation, among other things. Exposure to Korea and Taiwan also resulted in losses on the whole, while managers investing in Australia made good gains from regional equities, commodities and currencies.
However, managers in Japan (2.4%) had a good month, benefiting from long positions across domestic equities, as the Topix returned 3.6%, and from currency trades such as shorting the yen against both the euro and the US dollar, among other things.
The chart below illustrates the current month, previous month and year-to-date returns across geographical mandates.
Global Market Review
Equity fared reasonably well up to mid-month, after which the rally that was seen through April and into May, gave way. A notable surge in oil and other commodity prices brought heightened inflationary concerns to the fore, and in turn, adversely affected many markets during the month. The MSCI World Index, after gaining over 3% intra-month, slid lower to finish the month up 1.1%.
In North America, the S&P 500 touched a 4-month high during the month, but declined from that level, to close the month up 1.1%. Negative macro-economic data emanating from the US, among some other factors, impacted investor sentiments during the later part of the month. In Europe, the FTSE (-0.6%) finished the month negative, on the back of growing concerns about the domestic economy, and a further decline in house prices across the region.
Latin American markets had a strong month, with the MSCI Latin America Index up an outstanding 9.1%. The strong performance of the Brazilian markets, partly owing to its external debt being upgraded to investment grade by Fitch, was among the factors that kept the region in good stead through the month; MSCI's Brazilian index returned a notable 11.4% on the month. Stocks in Argentina fared well too, posting double-digit gains, while markets in Columbia and Mexico were up 4.1% and 5.8% respectively.
In the Asia Pacific region, Japanese stocks rose 3.6% partly on the back of the weaker yen, with small- and mid-caps outperforming their larger-caps counterparts during the month. Australian stocks were up in excess of 2%, as the energy sector had a strong month on the back surging crude oil prices; the property sector, however, fared poorly in May.
Asian emerging markets had a relatively rough month, as most regional equity indices tumbled further. Stocks in China and India, for instance, finished the month lower by 7% and 5.7% respectively. A devastating earthquake shook China in early May, with inflation concerns and a slowing economic growth pulling stocks further down. The Indian market saw significant withdrawals from FIIs, following the spike in crude prices; high inflation also added to the concerns of investors in the region. Stocks in Taiwan lost 3.4%, largely owing to profit-taking. However, Korea's Kospi rose 1.5%, on the back of a weaker won.
The fixed income markets had a difficult month, amid an environment of higher short-term rates. This was due to widespread expectations that central banks like the Fed and the ECB would raise their respective benchmark rates to deal with rising inflation, as growth across both regions met expectations, if not outdid them. The yield on the US 90-day T-bill rose 51 bps during the month.
The currency markets saw the US dollar close marginally higher (0.4%) against the euro, and up 1.5% against the yen, on the back of some positive news (such as stronger-than-expected home sales) in the US. However, most other major currencies strengthened against the dollar; the Australian dollar and the Brazilian real appreciated 1.4% and 2.2% respectively.
The commodity markets had a strong month, with crude oil making yet another record on the back of concerns regarding spare capacity, and discouraging comments from the OPEC about no increase in production. Precious metals had a good month too, with gold, among others, closing considerably higher on the month.
The chart below illustrates the current month, previous month and year-to-date returns across different strategic mandates.
Performance of Strategic Mandates
A) Arbitrage and Relative Value
The Eurekahedge Arbitrage and Relative Value Hedge Fund indices were up 0.8% and 1.6% respectively, in May. Managers of both strategies made decent gains from convertible arbitrage activity, during the month. Furthermore, a pick-up in M&A activity across the board also afforded managers of the strategies with merger arbitrage opportunities in May.
In North America, arbitrageurs were up 1.3% while relative value managers returned 4%. Most gains in the region for both strategies were realised from convertible arbitrage trades, as convertibles (particularly credit-sensitive convertibles) fared well. Furthermore, a good amount of new issuance in the region, coupled with a sharp increase in treasury yields also afforded managers of the strategies with some profitable opportunities.
European arbitrage and relative value managers were up 0.8% and 1.4% respectively. The region saw decent returns being realised from relative value trades in the fixed income space (such as short positions in both 10-year bonds and short-term rates in the UK, as well as in Europe). Arbitrage trades across currencies - such as long positions in the sterling against the Swiss franc, for instance - also proved profitable on the month.
Asia ex-Japan focused relative value managers recorded returns averaging 3.5%, mainly owing to an over 7% return for one Australia-focused market neutral index constituent. Some statistical arbitrage pair trades across the banking, infrastructure and energy sectors proved profitable in Australia. However, some positions looking to exploit pricing inefficiencies between the China A-shares versus the H-shares markets resulted in losses over May.
B) Long/Short Equities and Event-driven
Long/short equity managers had a strong month this May, as the Eurekahedge Long/Short Equities Hedge Fund Index rose 2.4%. Most regions (with the notable exception of Asia ex-Japan) recorded good gains over the month, exploiting opportunities on both the long and short side, as suggested by the relatively modest return of 1.1% of the MSCI World Index.
North American funds were up 2.9%, against a 1.1% return of the S&P 500. Managers in the region made decent gains from long exposure to technology (owing to improving fundamentals across telecom names) and consumer-related sectors (on the back of better-than-expected consumer spending data). Stocks across the industrial, materials and real estate sectors were down on the month, thus proving profitable to the short book.
The European index for the strategy was up 2.3%, with the best returns coming from managers allocating to the Eastern European region (6.7%). On the whole, managers considerably outperformed the MSCI Europe Index (-0.5%), benefiting from the decent performance of energy and material-related stocks (which did well on the back of surging oil and raw material prices), and from shorting consumer-related stocks (which were adversely affected by the surge in material costs).
In Latin America, long/short equities was the best performing strategy in May, as managers registered returns averaging 3.7% on the month. While most managers with exposure to Brazil made impressive gains during the month (as an upgrade of the country's external debt to investment grade resulted in a good amount of inflow from investors), some also benefited from their investments in Argentina, Columbia and Mexico. In terms of sectors, oil and gas were among the most profitable across the region.
Japanese long/short funds returned 2.5% against a 3.6% increase in the Topix. Long positions in the capital goods sector did well, and short exposure to the banking, retails and some other financial sectors also worked favourably. A weaker yen went some way in benefiting export-related sectors on the month.
Equity-focused managers in the Asia ex-Japan (0.2%) region had a rather disappointing month, as regional equities (in India, Hong Kong, China and Taiwan) were in negative territory as at end of May. High oil prices and inflationary pressures led FIIs to pull out funds from the Indian markets, pulling stocks down, as a result of which Indian managers lost 8%. Managers allocating to Greater China were up 0.9%, despite stocks in China, Hong Kong and Taiwan finishing the month down. These gains were realised from exposure to the technology sector in China (which did well on the back of strong IT spending in the country). Furthermore, exposure to the cement and steel sector also proved profitable, as the sectors benefited (in an economic sense) from the devastating earthquake that hit the region.
Long/short managers allocating to Australia/New Zealand were up a solid 5.4%, against an increase of 1.9% in Australian stocks and a 0.1% decline in the MSCI New Zealand Index. Profits were realised on both the long and the short side; long exposure to the Australian energy sector, and shorts in the Australian real estate sector proved rewarding in May.
The Eurekahedge Event Driven Hedge Fund Index rose 1.9% in May, as M&A activity gained some momentum in the course of the month. The strategy's North American index was up 4.1% largely due to one constituent returning over 20% during the month; however, other managers also did well on the whole, benefiting from special situations in the region (such as the withdrawal of Microsoft's bid for yahoo, and the re-negotiation in the transaction price for the buyout of Clear Channel communications, etc). European managers were up 1%, on the back of some corporate activity (such as the finalisation of the Alltracel deal, for instance) across the region.
The Eurekahedge Asia ex-Japan Event Driven Hedge Fund Index finished the month flat (-0.1%), as some managers finished the month down; however, some (particularly in Australia) had a good month benefiting from special situations such as the proposed merger between Westpac and St. George (the completion of which would result in Australia's largest financial institution). Japanese managers (2%) had a strong month, on the back of some M&A activity in the region (such as the completion of the acquisition of Millennium Pharmaceuticals Inc by Takeda Pharmaceutical Company Limited, for instance). Latin American event driven players were up 2.3%, as among other things, pair trades in the energy, telecom, financial and steel sectors proved favourable.
C) Fixed Income and Distressed Debt
Fixed-income managers (0.5%) recorded subdued returns in May, as most fixed income instruments finished the month in negative territory amid an environment of higher short-term interest rates and tighter credit spreads. Managers made a good portion of their month's returns from short positions across bonds and treasuries, among other things.
North American managers were up 1%, as short positions across treasuries proved rewarding; yields on the US 10-year T-note and the US 90-day T-bill rose 29 bps and 51 bps respectively. Additionally, tighter spreads coupled with a modest gain in the high yield market, also afforded managers of the strategy with opportunities to profit from during the month.
European fixed income managers were down 0.6%. Better-than-expected 1Q2008 GDP numbers - which to some extent, led to an increase in the yield on government bonds in the region - were among the factors responsible for the month's losses. On the whole, trades focusing on the yield curve in Europe also resulted in losses, owing to a flattening in the UK yield curve in May.
Latin American fixed income managers recorded healthy gains of 1%, as corporate holdings in the region, particularly across Columbia and Brazil, turned out to be fruitful.
Asia ex-Japan focused managers were up 0.8%, as short exposure to 10-year Australian bonds resulted in decent gains. Broader regional mandates with exposure (shorts) to Japanese government bonds, which were down nearly 1.5% in May, also saw some profits by the month-end.
Distressed debt managers had a good month in May, as the Eurekahedge Distressed Debt Hedge Fund Index rose 1.4% on the month. Managers of the strategy enjoyed decent returns from their exposure to the high yield market, which did moderately well across the board in May. The strategy's North American index returned 1.5%, with managers making good gains from some well selected credits; a number of short positions across the high yield space also turned out to be favourable. The Eurekahedge Asia ex-Japan Event Driven Hedge Fund Index was relatively flat (0.4%) during the month.
D) CTA/Managed Futures and Macro
The Eurekahedge CTA/Managed Futures Hedge Fund Index rose 2% in May, with managers across the board benefiting from a surge in commodity prices. North American managers were up 1.3%, making healthy gains from their exposure to commodities - namely crude oil and precious metals, among some others; some currency trades (shorting the euro and the yen against the US dollar) also resulted in profits. Likewise, managers of the strategy focused in Europe and Asia also made decent gains from their investments in the commodity markets. The former realised some gains from shorting the yen against the euro, while short positions in the yen and long positions in the Australian dollar (both against the US dollar) worked to benefit the latter.
The Eurekahedge Macro Hedge Fund Index returned 1.7%, with the best returns coming from Latin America. Managers profited from the region's equity markets (the MSCI Latin America Index rose 9.1%), the strengthening of regional currencies (the Brazilian real and the Argentinean Peso appreciated by over 2% against the US dollar) and from the overall strength in the region's (particularly Brazil's) economy.
Managers in North America benefited from long and short positions in equities - in addition to directional trends in commodities and currencies; furthermore, a sharp increase in treasury yields also afforded managers across the region with decent opportunities on the short side. Similarly, macro managers with exposure to Europe made gains from, apart from other things, trading currencies; however, some managers betting on a weaker euro (against the yen) saw some losses on the month.
In Asia, returns were mixed across different sub-regions and strategies. Exposure to equities in Asia ex-Japan generally resulted in losses; however, investments in Japanese equities, bets in favour of the Australian dollar (against the US dollar) and shorts in the yen (against the US dollar) proved rewarding.
Multi-strategy managers registered returns averaging a healthy 1.8% in May, as most trading styles across most regions recorded profits. In terms of regional mandates, European managers (5.5%) were the biggest contributors to the index, largely due to the returns of those allocating to Eastern Europe and Russia (9.6%). Managers in Eastern Europe realised good profits from regional equities (the MSCI Eastern Europe Index returned 12.7% during the month), the performance of which was largely catalysed by rallying oil prices during the month. Managers in other parts of Europe made some gains from regional equities (from both long and short positions), currencies and commodities; fixed income trades, though, fared flat to negative during the month.
Among other mandates, North American managers were up 2%, with exposure to regional equities, commodities and currencies contributing to the month's returns. Short exposure to the fixed income markets (as treasury yields saw a notable rise) fetched some gains during the month also. Japanese managers returned 1.8%, making most of their gains from domestic equities, as the Nikkei recorded a return of 3.5% on the month; some gains were also realised from currency trades (from shorting the yen against many major currencies) and from fixed income trades (by shorting JGBs, which were down 1.5% over May).
Latin American managers were up 1.4%, making their month's returns from equities across the region (equities indices of Brazil, Argentina, Columbia and Mexico all recorded positive returns) and from currencies, as most regional currencies appreciated against the US dollar. Asia ex-Japan focused managers (-0.02%) were the only ones to finish the month absolute flat, as exposure to equities among most regions (except in Australia) resulted in losses. However, exposure to Australian equities and currency trades such as long positions in the Australian dollar (against the US dollar), afforded managers of the broad mandate (Asia ex-Japan) with opportunities to offset some of their losses.
May was an impressive month for hedge funds despite some stress in the underlying markets - in terms of inflationary pressures, uncertainties about economic growth and some volatility across the equity markets.
As for different asset classes in June (to-date), oil and some other commodities which shook the markets in May, continues to trade at abnormally high levels. Equities, which took a downturn around mid-may, have stuck to their downward trend for the month-to-date. The US dollar has strengthened further against some major currencies over June so far, and treasury yields have also continued their upward movement. Should inflationary pressures persist much longer, chances are that markets might continue following their current trend. However, should central banks across the board succeed in bringing inflation under control, there are high chances that the oversold equity markets might move upwards and commodity prices might show signs of normalising. One way or another, managers employing strategies such as long/short equities, CTA/managed futures and macro, among some others, would be exposed to lucrative opportunities to benefit from - either on the long side, or on the short (if not on both). However, managing their risks might be of utmost importance in the near to medium term.
On the macroeconomic front, fears about a recession in the US have diminished to some extent. Furthermore, comments from the Fed regarding higher US interest rates and better-than-expected US home sales data, together with an upward revision of the US 1Q2008 GDP data, have come across as positive news amid troubled markets. However, there still remains a huge responsibility on the Fed (and other central banks) - that of bringing inflation under control without further slowing the existing slow pace of economic growth. It would indeed be interesting to observe how the Fed goes about in doing so, and to see the impact that their moves would have on different asset classes, and in turn on hedge fund performance in the near to medium term.
1 Based on 52.43% of the funds reporting the May 2008 returns as at 13 Jun 2008.