Research

Hedge Fund Performance Commentary

Introduction

The composite Eurekahedge Hedge Fund Index returned an impressive 2.6% in Nov (and 11.5% for the year to date) with equally promising, if not better, returns among hedge fund strategies and regional mandates across the board. The key market event during the month was the declining US dollar (USD). During the month, the USD broke out of recent ranges and reached multi-year lows against a range of currencies, owing to a host of reasons. Given the slowdown in US economic growth, investors expecting the Federal Reserve to begin loosening its monetary policy in 2007, and the attendant benign inflationary outlook, the markets imply a narrowing of interest rate differentials and the US advantage of positive interest rate differentials continues to weaken. Another factor was fear over the future distribution of foreign exchange reserves, as China announced that its reserves exceeded USD1 trillion at the start of Nov, with 70% of it denominated in USD.

While global equities maintained their momentum into Nov (driven as they were by strong corporate earnings and healthy deal flow), they underwent some correction towards the end of the month owing to the declining USD. Bond and interest markets rallied through the month as markets discounted higher interest rates into 2007.

Energy markets, on the other hand, were relatively more difficult to trade. Prices reversed upwards during the middle of the month on the back of declining US inventories, the onset of colder weather and the effects of the previous month’s OPEC production cuts kicking in.

Amid this backdrop, all hedge fund strategies had a very good month (upwards of 1% returns), with long/short, relative value and CTA managers rising nearly 3% on average. Consequently, multi-strategy funds posted impressive returns as well at 3%. Long/short managers benefited from the uptrend in equities and managed to sidestep the end-of-the-month price reversal, while movements in the currency and equity markets helped CTA managers offset losses in energy trading.

Regional hedge fund returns too were, in the main, very positive, with the possible exception of those of Japanese funds. Funds allocating to Asia ex Japan had by far the best returns during the month (a five-year high at 5.7%), clearly benefiting from the long bias of their directional strategies. The underlying reasons for the month’s regional hedge fund performance are taken up in detail in the following sections.

Hedge Fund Performance by Investment Region

North America
Europe
Japan
Asia ex Japan
Latin America

North America

Despite weak economic data releases and indications of a slowdown in the housing market, the US equity markets were buoyed by a benign inflationary outlook and a Democratic victory in the Senate and Congressional elections. The S&P500 index rose 1.9% and reached six-year highs in the process. Consequently, long/short equities managers had a terrific month and rose 2.5% during Nov.

The month’s best returns, however, came from the CTA managers (+3.9%) benefiting from their currency trades, as the USD came under significant pressure on narrowing interest rate differentials, and weakened against most major currencies. Oil prices rose back up from an 18-month low, touching the USD60/barrel mark amid supply concerns and the OPEC production cuts, while natural gas prices too rose to multi-month highs as cold weather took hold.

In the bond and interest rate markets, easing inflationary pressures and weak economic data supported a fall in bond yields for the fifth consecutive month, with the benchmark ten-year US Treasury Note closing at 4.46%. The high-yield market also was strong during the month, advancing 1.6% and absorbing USD30 billion in new issuance. Convertibles too, saw active new issuance in Nov (24 deals worth over USD9 billion). The LBO trend continues with several high-profile companies slated as takeover targets in the press. Amid this backdrop, relative value (+2.2%) and distressed debt (+1.8%) posted decent gains for Nov. 

Strategy Nov 20061Oct 20062006 YTD20052004
Arbitrage0.77%0.82%9.44%2.54%5.44%
CTA / Managed Futures3.91%0.63%6.20%1.62%5.23%
Distressed Debt1.81%2.15%12.08%11.68%20.80%
Event-Driven1.54%2.38%11.77%7.90%16.90%
Fixed Income0.36%0.57%5.91%4.54%9.04%
Long/Short Equities2.49%1.86%8.63%7.85%9.29%
Macro-1.19%-1.46%2.01%12.44%7.41%
Multi-Strategy1.82%1.48%11.31%6.50%13.60%
Relative Value2.15%2.61%10.04%7.24%12.53%
Eurekahedge North American Hedge Fund Index2.26%1.58%9.15%6.79%9.83%

Europe

European markets are witnessing an improving economic outlook, as GDP growth is estimated at 2.6% and Germany’s Ifo sentiment index reached 15-year highs. This notwithstanding, European interest rate markets rallied on the back of a stronger Euro.

European equities also rallied strongly on the back of positive corporate earnings and high activity levels in the M&A space (with deals such as Iberdola’s bid for ScottishPower, and CSN’s bid for Corus), but reversed direction towards the month’s close, owing to the stronger Euro. This reversal somewhat dampened the otherwise decent Nov returns of long/short managers in the region (+1.3%).

In emerging Europe as well, Russia saw strong investment flows (as tax and legislation affecting investment activity improved) and a rally in equities (driven by oil and gas stocks) and bonds (the Russian Emerging Markets Bond Index rose 1.7%).

Fixed income funds were by far the region’s best-performing strategy during the month (+2.5%), as positions anticipating a continuation of the inverted rate structure in the US proved very profitable.

StrategyNov 20061Oct 20062006 YTD20052004
Arbitrage0.18%0.26%4.48%0.55%-1.34%
CTA / Managed Futures0.77%-4.79%4.73%0.50%-5.30%
Distressed Debt 0.58%1.01%7.70%9.12%17.26%
Event-Driven0.49%2.39%6.66%8.66%8.07%
Fixed Income2.45%1.12%6.67%4.25%9.53%
Long/Short Equities1.26%1.83%7.57%13.82%9.13%
Multi-Strategy0.73%1.76%5.56%10.63%8.34%
Relative Value0.04%1.44%6.20%9.04%3.83%
Eurekahedge European Hedge Fund Index1.15%1.51%7.10%11.99%7.64%

Japan

In another month of generally positive economic data but poor share price performance, the Japanese markets saw yet more new lows in the small-cap segment, as interim financial results showed weaker-than-expected earnings projections. But impressive corporate spending, exports and Q3 earnings data triggered a sharp rally towards the month-end. As a result, the JASDAQ Index fell by 4.6% for the month, while the TOPIX fell 0.9%.   The Yen strengthened steadily over the month against the USD, but this was somewhat offset by weakness against the Euro.

As a result, most Japan-focused strategies had another rough month in Nov (-0.8% on average), with the possible exception of relative value players who had a marginally positive month at returns of +0.2%.

StrategyNov 20061Oct 20062006 YTD20052004
Long/Short Equities-0.75%0.16%-5.07%22.68%8.07%
Multi-Strategy-0.25%-0.29%-6.26%16.75%41.93%
Relative Value0.20%-0.85%2.93%6.10%3.54%
Eurekahedge Japan Hedge Fund Index -0.76%0.29%-5.56%23.62%9.79%

Asia ex Japan

Equity prices in the rest of Asia continued to march up as investors positioned themselves for the traditional year-end rally, driven by strong liquidity inflows and falling US treasury yields. Equity markets in Hong Kong, Australia, India, the Philippines and Indonesia, all witnessed multi-year highs.

China and India continue to be the focus of investor interest in the region, with the strong growth theme in the two economies. In India, for instance, equities had a very strong month and registered the sixth consecutive month with an uptrend. The Sensex gained 6.4% during the month. Foreign institutional investment (FII) continued to flow inward at a healthy rate, with net FII inflows exceeding USD2 billion for the month.

In Australia, the ASX 300 Accumulation Index was up 2.4% for the month, as Australian equities rallied as well, and private equity interest in Australian markets continues to be supported.   As a result, most of the region’s strategies had a terrific month, with returns even breaching the 6% mark, as was the case with event-driven funds. This is not surprising given the continued high levels of M&A activity in the region. The Indian real estate sector is a case in point, having seen a total foreign inflow of over USD10 billion for the year to date.

StrategyNov 20061Oct 20062006 YTD20052004
Distressed Debt0.82%1.69%9.08%9.54%18.94%
Event-Driven6.29%2.54%27.54%8.82%19.76%
Fixed Income1.64%1.64%7.11%10.53%13.01%
Long/Short Equities5.04%3.19%19.70%12.56%8.33%
Multi-Strategy8.55%3.85%27.48%9.97%10.08%
Relative Value4.99%6.00%16.72%20.09%-1.01%
Eurekahedge Asia ex Japan Hedge Fund Index5.70%3.23%21.08%12.12%9.00%

Latin America

The Eurekahedge Latin American Hedge Fund Index too posted robust gains at 2.9%, in yet another rising equity market environment (the MSCI Latin America Equity Index was up 5.3% during Nov). This was despite the fact the Q3 earnings data released in Nov were not as positive as those released in Oct.

Strong equities, heightened M&A activity (three deals were announced in Nov alone, including the merger announcement between two of Brazil’s largest online retailers – Lojas Americanas and Submarino), strong liquidity inflows and favourable global economic conditions continue to help the regional markets. These conditions also proved profitable for equity-focused long/short managers (+4.4%) and directional macro (+1.4%) players.

StrategyNov 20061 Oct 20062006 YTD20052004
Event-Driven3.43%1.43%20.59%27.22%26.68%
Fixed Income0.97%1.16%13.38%19.29%15.97%
Long/Short Equities4.38%3.41%18.88%22.66%31.85%
Macro1.39%2.25%16.52%12.14%10.91%
Multi-Strategy1.29%1.83%15.43%18.87%19.60%
Eurekahedge Latin American Hedge Fund Index2.88%2.40%17.14%18.81%21.97%

In Closing

To summarise, Nov was a very good month for hedge funds, given an environment of benign inflation, and positive corporate earnings and cash flows. Opportunities were to be found during the month in the rallying equity markets, heightened deal flow, and the declining USD. 

As the year draws to a close, equities continue to remain generally resilient to negative news, and M&A activity as well as the outlook for new issuance remain strong. As a result, we are optimistic about the performance of hedge funds in the coming month, especially in directional and opportunistic strategies.

Please visit ../indices for daily-updated numbers on index returns for Nov.

Footnote

1 Based on 47.69% of the NAV for Nov 2006 as at 12 Dec 2006

2 The 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.

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