Research

Hedge Fund Performance Commentary

Introduction

The Eurekahedge Hedge Fund Index closed the month of September up 6 basis points1 (and 6.3% year to date) amidst a moderately slowing US economy, a sharp drop in energy and commodity prices, and continued strength in equities and treasuries as the markets continued to conjecture that the Federal Reserve is done raising rates. There was also a major hedge-fund-industry-specific market event during the month – the liquidation of the significant portfolio of Amaranth Advisors, which was hurt by plummeting natural gas prices – and this played catalyst to a spate of liquidity-driven selling that proved beneficial to a few hedge fund strategies such as arbitrage and distressed debt, especially among North American managers.

But on the whole, Asia ex Japan was the best performing region for the month (the Eurekahedge Asia ex Japan Hedge Fund Index closed the month up an impressive 2%) given the positive effects of the fallout in oil prices for economies that are heavy importers of oil. Latin American funds had to contend with volatile markets owing to the uncertainty surrounding the Brazilian presidential elections, and posted slightly lesser returns in comparison.
 


Source: Eurekahedge

Global Market Review

The financial markets lacked any clear direction during the month. Treasuries rallied with deteriorating house prices, benign inflation data, a pause in the Fed rate-hike cycle for a second consecutive month, and falling energy prices. Equity markets rallied to multi-year highs as well, on subdued inflation fears. In the currency markets, the month saw a reversal of the weak Japanese yen trend seen in August, while other major currencies were largely range-bound.

On the other hand, growing inventory levels in the face of lower-than-expected demand for the winter season ahead, coupled with a reduction in geo-political tensions in the Middle East, pushed energy prices further down during the month. Crude oil fell from US$70 to a barrel at the beginning of the month, to US$62 at month-end.

In other major news, Amaranth Advisors, a US$10 billion Connecticut-based, multi-strategy fund, lost 35% of its assets in natural gas positions (natural gas prices fell over 30% during the month) and nearly another 35% in forced liquidations of other positions to meet margin calls.

Given this backdrop, most global hedge fund strategies, had a mildly positive month (arbitrage and event driven being the only strategies with notable positive returns). The exceptions were CTA and directional macro strategies, which were down 1.1% and 1% respectively.


Source: Eurekahedge

Hedge Fund Performance by Investment Region

North America
Europe
Japan
Asia ex-Japan
Latin America

North America

The Eurekahedge North American Hedge Fund Index was nearly flat for September at 0.1% returns, as equity- and commodity-focused funds took losses stemming primarily from positions influenced by the dramatic sell-off in the energy markets.

Arbitrage, distressed debt and fixed income were among the better performing strategies among North American hedge funds in September, each returning approximately 0.7% for the month. This was on account of robust earnings growth, benign inflation and interest rate data (the markets continue to conjecture that the Federal Reserve is done raising rates) and the consequent strength in equities and treasuries. Both the S&P 500 and the DJIA were up about 2.5% each, while the treasury and credit markets continued to rally (10-year and 5-year yields shed 10 basis points each and closed the month at 4.63% and 4.59% respectively). The perceived end to the rate hike cycle, coupled with a moderately slowing US economy and a steep fall in energy and commodity prices, flattened the yield curve. Most of the returns in the high yield markets came from BB-rated names that tracked the treasury rally as well as from names that were buoyed by declining oil prices. Also, the convertibles market had a strong month in September given continued attractive valuations and a healthy new issues calendar (18 deals adding up to US$5.8 billion during the month).

 
Source: Eurekahedge

Strategy Sep-061 Aug-06 ‘06 YTD 2005 2004
Arbitrage 0.71% 0.91% 8.59% 2.58% 5.38%
CTA/Managed Futures -1.30% 0.41% 2.04% 1.62% 5.03%
Distressed Debt 0.79% 1.02% 10.77% 11.62% 22.96%
Event Driven 0.37% 1.36% 10.10% 7.52% 16.31%
Fixed Income 0.64% 0.90% 5.18% 4.26% 8.98%
Long/Short Equities 0.02% 1.13% 6.35% 7.78% 9.30%
Macro -0.19% -0.36% 5.57% 12.43% 7.23%
Multi Strategy -0.08% 0.24% 9.30% 5.65% 13.27%
Relative Value 0.08% 1.13% 7.01% 7.34% 12.51%
Eurekahedge North American Hedge Fund Index 0.06% 0.98% 6.89% 6.84% 9.94%

Source: Eurekahedge

Europe

European hedge funds posted similarly moderate gains (0.4%) for the month. M&A was the dominant theme in September – Endesa received a bid from Eon at 35 euros, rumours of a tie-up between EMI and Warner, as well as rumours of private equity interests between Corus and Vivendi. Consequently, European event-driven funds had a stellar run (2.9%).

Fixed income funds gained in relative value and volatility trades (1.7%), as the European yield curves witnessed flattening beyond 5-year maturities.

On the flip side, the euro weakened fractionally overall in September, moving from 1.28 to 1.27 against the US dollar, in choppy markets with economic data swaying sentiment one way and the other but creating no overall market direction. This and the sell-off in the commodity markets saw managed futures funds take the month’s biggest losses (-1.4%) among hedge fund strategies in the region.


Source: Eurekahedge

Strategy Sep-061 Aug-06 ‘06 YTD 2005 2004
Arbitrage 0.29% 0.63% 4.36% 0.69% -1.32%
CTA/Managed Futures -1.41% 4.25% 5.13% 0.04% -5.16%
Distressed Debt 0.04% 0.72% 6.57% 9.12% 17.26%
Event Driven 2.93% 0.85% 10.50% 9.81% 8.62%
Fixed Income 1.67% 0.65% 4.01% 4.18% 9.53%
Long/Short Equities 0.50% 0.65% 6.83% 14.59% 9.46%
Multi Strategy -0.36% 1.05% 7.82% 14.88% 11.92%
Relative Value -0.03% 0.05% 5.39% 6.30% 2.48%
Eurekahedge European Hedge Fund Index 0.36% 0.77% 6.54% 12.55% 8.10%

Source: Eurekahedge

Japan

The Japanese markets in general have been difficult in the past few months with no discernible trends or themes and low volumes and weak price momentum (the September returns for the Topix and Nikkei indices were -1.5% and -0.1% respectively). For instance, an unexpectedly strong capital expenditure figure from Japan at the start of the month sharply reversed the previous month’s Japanese yen depreciation, with the Euro/JPY rate moving from 150.32 to 148.18, although the yen drifted lower again into month-end.

A spate of poor economic data released in August and early September were further compounded by slowing US economy in general, and slowing US housing numbers in particular, led to continued bearish conditions in the Japanese equity markets and yet another down month for hedge funds in the region. The Eurekahedge Japan Hedge Fund Index was down 0.7% for September and 4.9% year to date. It was a broad-based downturn with negative returns across most strategies for the month. 

 
Source: Eurekahedge

Strategy Sep-061 Aug-06 ‘06 YTD 2005 2004
Event Driven -1.49% 2.03% -9.76% 45.92% 43.50%
Long/Short -0.53% 1.24% -4.56% 23.41% 8.19%
Multi Strategy -0.38% -0.39% -6.06% 16.51% 33.37%
Relative Value 0.16% -1.26% 2.80% 5.55% 3.51%
Eurekahedge Japan Hedge Fund Index2 -0.67% 1.09% -4.89% 23.76% 9.48%

Source: Eurekahedge

Asia ex Japan

The Asian ex Japan markets rallied an impressive 6.2% during the third quarter, driven by falling inflation and interest rate expectations, the strength of domestic economies, moderating geopolitical tensions and still abundant liquidity. As a result, hedge funds in the region were up 2% for the month, posting the best returns for the month by a wide margin. Asian countries, which are generally heavy importers of oil, capitalised on the month’s fallout in oil prices. Most notably, regional arbitrage strategies returned a whopping 6.6% as emerging market equities, credits, currencies and yields got a boost from investors looking to put money in risky assets, while event-driven funds (2.5%) benefited from high M&A activity levels in the region, especially in China and Australia. A review of events in some of the key regional economies is as follows:
 
In China, as US interest rate fears have largely been allayed, liquidity flows into the region remained robust and broad economic and corporate data continued to be strong. For instance, trade surplus is still going strong although kept in check by the gradual appreciation of the renminbi and increases in minimum wages, while ICBC, which would be listed by the end of October, has been billed as the largest ever IPO in the world. Taiwan too saw strongly bullish equity markets during September, managing a 4% gain.

India, which imports 70% of its oil needs, saw markets rally strongly in September as the steep fall in oil prices revived hopes of lower inflation and interest rates in the coming months. The Indian economy too is still in good shape with strong corporate earnings and expanding new lending.

Australian equities, on the other hand, had a volatile month and moved up by 1.3%, with a sharp increase in M&A activity and a sell-off in large-cap resource stocks as investors became jittery about the slowdown in global growth.

In Korea, the markets remain resilient on the back of a benign macro outlook (the export trend continues to be robust at 22% year-on-year growth in September) and broad-based earnings resilience.

In Thailand, Prime Minister Shinawatra was ousted in a bloodless coup which had minimal effect on Thai stocks.

                                                                                                          
 
Source: Eurekahedge

Strategy Sep-061 Aug-06 ‘06 YTD 2005 2004
Arbitrage 6.64% 1.84% 28.42% 5.24% -1.79%
Distressed Debt 0.28% 0.47% 8.10% 9.33% 19.12%
Event Driven 2.49% 1.90% 16.88% 8.99% 19.76%
Fixed Income 1.23% 1.34% 5.34% 11.88% 14.67%
Long/Short Equities 1.56% 1.74% 14.09% 12.35% 9.63%
Macro 3.19% 1.38% 17.13% 9.54% 10.79%
Multi Strategy 3.22% 3.34% 11.61% 19.75% -1.34%
Relative Value 2.04% 1.67% 14.55% 11.91% 10.05%
Eurekahedge Asia ex Japan Hedge Fund Index 1.83% 1.65% 14.23% 11.88% 10.00%

Source: Eurekahedge

Latin America

The Brazilian equity market index, Ibovespa, was down 0.9% in September with a good dose of volatility, given the continued outflow from foreign investors, and uncertainty owing to the impending second round of presidential elections. That said, Brazil continues to show signs of economic health (inflation below the 2006 Central Bank target and sound trade surplus and fiscal performance).

Exposure to Mexico was also positive as predictions of a US slowdown have become less pronounced.

Amid this backdrop, most Latin American hedge fund strategies had a decent run, returning close to or above a three-quarter percentage point in returns, with the Eurekahedge Latin American Hedge Fund Index itself up 0.8% for the month. Event-driven funds posted the best returns in the region (1.8%) given the significant number of corporate-related events announced or speculated, especially in the telecom sector (Mexico, for instance, is witnessing consolidation among paid TV and fixed line companies).


Source: Eurekahedge

Strategy Sep-061 Aug-06 ‘06 YTD 2005 2004
Event Driven 1.84% 2.46% 17.64% 27.43% 26.68%
Fixed Income 0.98% 1.37% 12.20% 19.29% 15.97%
Long/Short Equities 0.89% 1.86% 14.04% 22.57% 31.03%
Macro 0.59% 1.01% 13.76% 12.49% 11.30%
Multi Strategy 0.77% 1.71% 13.84% 18.89% 19.89%
Eurekahedge Latin American Hedge Fund Index 0.83% 1.65% 13.93% 18.79% 21.92%

Source: Eurekahedge

In Closing

To summarise, global hedge fund performance during September was largely flat, despite rallies in global equities and treasuries. This was owing to the fact that the beta-driven rally in the equity markets excluded many of the value stocks where hedge funds usually invest, while tight fixed income spreads and flat yield curves limited opportunities in treasuries as well.
 
Going forward, October is typically characterised by heightened equity volatility due to corporate earnings reporting and other seasonal factors. Also, M&A activity continues to be a strong global theme, given a low cost of debt, slowing corporate earnings growth and the increasing presence of private equity money. On the back of these factors, we expect the coming months to afford good opportunities for pair-trading and opportunistic funds. 

 

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

 

Footnote


1 Based on 66.23% of the NAV for Sep-2006 as at 16-Oct-2006.

2 The Eurekahedge Japan Hedge Fund Index is a separate 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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