Hedge funds largely outperformed the underlying markets in June, with the Eurekahedge Hedge Fund Index down 0.5%1 on the month. This decline was seen in the face of wide swings across key asset classes – the MSCI World Index plunged 8.1% on the month, while energy prices witnessed a sharp run up, with crude oil hitting another record high (over US$140 to the barrel at month’s end).
On the whole, long positions in equities across the board resulted in losses, most of which were offset by exposure to the commodity markets. Movements across the currency markets, as the US dollar depreciated further against some major currencies, also went some way in offsetting losses suffered from other allocations.
In terms of regional mandates, North American and European managers were among the best performers during the month, as both finished the month relatively flat (-0.1% and -0.2% respectively). Managers across both regions suffered significant losses from long exposure to regional equities, most of which were offset by allocations to the commodity and currency markets, during the month. Some who were positioned in preparedness for the equity sell-offs, also benefited from short equity positions in their respective regions.
Latin American managers were not too far behind, with returns averaging -0.4% for the month. Again, long exposure to equity accounted for most of the losses across the region. However, an upward shift in the yield curve in Brazil, coupled with some special situations across the region (such as a US$3.6 billion IPO of OGX, an oil company in Brazil) afforded managers with some decent opportunities to minimise capital erosion, if not prevent it altogether.
Asian managers (-3.6%), on the whole, had another difficult month, largely owing to notable sell-offs across domestic stock markets. Asia ex-Japan-focused allocations were down 4.4%, as both emerging (China and India) and developed (Hong Kong, Australia and New Zealand) economies in the region saw sharp downturns in their respective equity indices. Exposure to Japan (-3%) also took a considerable hit, partly owing to a 6% decline in the Topix, coupled with a weaker yen.
The chart below illustrates the current month, previous month and year-to-date performance across the different investment regions.
Eurekahedge Performance Indices - 2008 YTD (Regions)
As mentioned earlier, the underlying markets witnessed wide swings in key asset classes over June. Equity markets sold off aggressively on the back of renewed uncertainties about the financial sector (as some large financial companies reported further write-downs), and heightened inflationary concerns spread across the board. Furthermore, a sharp rise in crude oil prices to yet another record high, coupled with widespread anticipation of weak 2Q2008 earnings data weighed on investors’ sentiment throughout June. Against this backdrop, North American and European equities shed close to 8% each, while emerging markets such as Brazil, China and India saw double-digit declines.
In the fixed income markets, bonds saw mixed performance in June, owing to the contrasting effects of inflationary pressures and equity declines on the bond markets. Treasury yields in the US rose considerably until mid-month, amid some interest rate speculation. However, a sharp downturn in equities and the decreased likelihood of an interest rate increase, went some way in pulling yields back down towards the month-end; the yield on the US 10-year T-note was down 7bps on a monthly basis. The bond markets in Japan, too, saw JGBs close slightly higher during June.
The commodity markets rallied strongly in June. Energy prices soared, with crude oil making yet another record high during the month, on the back of renewed tension in the Middle East, and reports of a dip in inventories and a weaker US dollar. Other commodities such as grains and softs, also had a strong month, with some making double-digit percentage gains during the month. Precious metals like gold and silver rose 4% each, as rising inflation and a weaker dollar went some way in increasing their demand.
The currency markets witnessed mixed movements during the month. The US dollar weakened against most major currencies (except the yen), partly because the Fed gave no indication of an interest rate increase, and left rates unchanged at their 25 June meeting. The euro strengthened 1.3% against the dollar, as market participants anticipated some monetary tightening by the ECB. The yen, however, slid marginally (0.6%) against the dollar, during the month.
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
Arbitrage managers had a flat to negative month this June, with returns averaging 0.2%. Reasonably high volatility across the equity markets went some way in creating short-term trading opportunities for managers, across the board. Against this backdrop, North American managers returned 0.7%, over the month, while their European counterparts were down 1.1% (partly owing to the poor performance of some model-driven funds).
As for relative value managers, they were down 0.9% in June. This was partly owing to the poor performance of the equity markets, which sold off aggressively during the month. Furthermore, deterioration in the European convertible space, and exposure to Nordic equities and credit markets, went some way in adversely impacting the performance of some managers in the region (-0.3%).
North American relative value managers (-1.1%) were also affected by the equity sell-off, but they benefited to some extent, from the volatility across the asset class. The negative returns of the strategy’s regional index can (to some extent) be attributed to the poor performance of a handful of managers, who suffered double-digit losses from their exposure to regional equities, and from investments across the real estate sector. However, while most long positions across the asset class resulted in losses, some managers did make some decent gains from equity shorts, during the month.
Relative value managers in Asia saw mixed returns, with the strategy’s Asian index (which includes funds allocating to both – Asia ex-Japan, as well as Japan) up 1%. A large portion of these gains came from short exposure to Australian equities, while funds investing in other areas within the Asia ex-Japan region finished the month in negative territory.
Arbitrage and Relative Value (Jun-08 and 2008-YTD Returns)
B) Long/Short Equities and Event-driven
June proved to be a fairly difficult month for long/short managers, who faced rough conditions amid a sharp sell-off across the underlying equity markets. The MSCI World Index declined 8.1% during the month, as equities sold off aggressively on the back of inflationary concerns, record crude prices and renewed uncertainties regarding the health of the financial sector. Against this, the Eurekahedge Long/Short Equities Hedge Fund Index shed 1.4%. The month saw managers of the strategy benefiting (either making gains or offsetting some losses) from their short exposure to equities across their respective regions.
North American managers were down 1.2%, against a sharp fall of 8.6% in the region’s S&P 500. Negative data emanating from the US, coupled with little action from the Fed to battle rising inflation, persistent concerns on slow economic growth, and anticipation of unpromising 2Q2008 corporate earnings data weighed the region’s markets down. Managers suffered losses from long exposure to sectors such as industrials and real estate during the month. However, short positions across the consumer discretionary sector worked to the benefit of managers, helping them offset a portion of their losses.
European equities declined 8.9%, as per MSCI’s European index, amid a visible slowdown in the region’s economic growth, and widespread concerns centred on inflation. In contrast to this, equity-focused hedge funds allocating to the region actually posted a positive performance, with the region’s long/short index up an impressive (modest, in absolute terms, but impressive in relative terms) 0.5%. Managers made good returns from shorts across consumer-related and discretionary sectors. Long positions across oil- and energy-related stocks also generated positive returns, which helped more-than-offset losses from other allocations.
Latin American managers finished relatively flat, but in negative territory, with returns averaging -0.5%. This was against a 7.7% downturn in regional equities, as per the MSCI Latin America Index, as regional markets were impacted by negative data from the US and general weakness across credit markets. Like in the case of most managers of the strategy, long positions across most sub-regions suffered losses, while short exposure proved somewhat rewarding. However, even though most regions saw declines in equities, the MSCI Argentina Index rose a whopping 13.6% during the month, affording managers allocating to the country with decent opportunities to profit from.
Asian managers were the worst performers over June, as the Eurekahedge Asia ex-Japan Long/Short Equities Hedge Fund Index shed 4.6% while Japan’s index for the strategy lost 2.4%. Managers allocating to Asia ex-Japan were affected by the poor performance of the equity markets – China’s Shanghai Composite Index and India’s BSE Sensex finished the month down 20.3% and 18% respectively – amid worries centred on rising inflation and significant withdrawals from FIIs. Australian markets (7.6%) also sold off aggressively, however short positions helped offset some of the losses suffered from long holdings. Managers allocating to Japan saw some losses coming from investments across the real estate, financials and materials sectors, amid a decline of 3.6% in the region’s index – the Topix.
Event-driven managers were also negatively impacted, to some extent, by the overall decline in most equity markets, as the Eurekahedge Event Driven Hedge Fund Index shed 0.9% on the month. The best performing region – Latin America – however, recorded healthy returns (1.4%), as managers benefited from some corporate activity across the region (such as a US$3.6 billion IPO of OGX – a Brazilian start-up oil company, for instance).
Managers allocating to Asia had a rough month, with Japanese allocations losing 1.6% and those in Asia ex-Japan down 3.3%, both being affected by sharp drawdowns across their regional equity markets. However, allocations to Australia proved relatively profitable (flat to positive) as some activity in the region, such as Westpac’s agreement on its merger with St George earlier in May, and BG’s US$12 billion takeover offer for Orion Energy, created some decent arbitrage opportunities.
European managers (-1.7%) were also hit by the sharp decline in equity markets within the region. Additionally, some managers also had to increase their cash positions to meet investor redemptions, thereby having to liquidate some holdings at existing low prices. North American managers were down 1%, as a sell-off across the domestic equity markets pulled stock prices significantly lower (S&P 500 lost 8.6% in June), while a slowdown in deals in the region also negatively impacted managers.
Long/Short and Event-driven (Jun-08 and 2008-YTD Returns)
C) Fixed Income and Distressed Debt
Fixed income managers finished the month of June in negative territory (-0.5%), amid an environment of widening credit spreads, discouraging economic data and worrisome levels of inflation, across the board. Furthermore, the inability of many central banks to raise interest rates adequately (to battle inflation), owing to concerns centred on further slowing of economic growth, adversely affected the markets.
In terms of regional mandates, North American managers were up 1.1%, benefiting from short exposure to treasuries, among other things. Yields on US treasuries rose considerably into the month, on the back of some interest rate speculation and inflationary pressures in the markets, but declined during the latter part of the month on the back of the equity sell-off. Yields on the US 90-day T-bill and the 10-year T-note fell 14bps and 7bps respectively, on a monthly basis.
Fixed income managers in Europe finished the month with mixed returns, with one index constituent posting a double-digit percentage loss, negatively skewing the index’s return to -1.6%. An interest rate increase by the ECB towards the month-end, worked positively for some managers who had positioned themselves in anticipation of the same, during the month. Exposure to the debt markets in the Eastern European region also translated into decent returns for some managers, while long-biased trades on the long end of UK yield curve resulted in losses.
In Latin America, managers recorded returns averaging 0.3%, as some gains were realised from long exposure to the Brazilian yield curve, which saw a sharp upward shift on the back of some monetary tightening within the region.
Distressed debt managers fared better, as the strategy’s index rose 0.7%, despite a discouraging month for the high yield debt markets and wider credit spreads. North American managers of the strategy returned 0.7%, as short exposure to the high yield markets translated into some gains, while managers in Asia ex-Japan (1.3%) benefited from their exposure to some non-performing loans across Greater China and from some special situation trades across the region.
Fixed Income and Distressed Debt (Jun-08 and 2008-YTD Returns)
D) CTA/Managed Futures and Macro
CTA/managed futures allocations were the most profitable in June, as the strategy’s index rose an impressive 3.1%. Managers across the board largely exploited the surge in commodity prices, during the month, as energy prices spiked. Crude oil made yet another record high, of over US$140/barrel in June, on the back of renewed tensions in the Middle East, coupled with reports of declining inventories of the resource. Additionally, grains, softs and precious metals also had a good month, with a bunch of commodities putting up double-digit percentage gains, and many others trading close to their record highs.
Both North American and European mandates for the strategy recorded impressive returns, averaging 3% and 3.3% respectively. In addition to commodity trades, bets in the currency markets – such as shorting the US dollar and the yen against the euro, for instance – also proved rewarding for both mandates.
The Eurekahedge Macro Hedge Fund Index, however, finished the month of June down 0.4%. This was largely due to the high volatility and sharp drawdowns seen across global equity indices, which came about as a result of rising inflation, record oil prices, and the re-emerging concerns about the financial sector. Losses from investments in the equity markets more-than-offset healthy returns from managers’ exposure to the commodity and currency markets, during the month.
CTA/Managed Futures and Macro (Jun-08 and 2008-YTD Returns)
The Eurekahedge Multi-Strategy Hedge Fund Index finished the month of June down 1.2%. In terms of regional mandates, North America fared the best with impressive gains at 1.6%, as regional managers of the strategy largely benefited from commodity trends, and to some extent, from currency movements. Short positions across equities also contributed to the month’s returns, while long exposure to the asset class suffered losses.
European and Asia-ex Japan-focused managers had a difficult month, as the mandates were down 3.4% and 4.1% respectively. The extent of losses for the European index can be attributed to the poor performance of a handful of managers in the region, who suffered double-digit losses over the month. On the whole, managers in the region recorded mixed returns, with most being negatively impacted by the volatility across equities. Commodity and currency trades went some way in offsetting a portion of their losses. In the Asia ex-Japan region, managers were largely affected by the sharp plunge in equity prices, across countries like China, India, Korea and Taiwan.
Japanese and Latin American multi-strategy managers finished the month flat (0.03% and 0.1% respectively). The former made some gains from short positions across equities, and from shorting the domestic currency against the US dollar and the euro. However, long exposure to equities wiped out a good portion of these gains, resulting in flat returns for the month. Latin American managers were afforded with lucrative opportunities in the currency markets, as the Brazilian Real and the Argentine Peso strengthened 1.4% and 2.4% respectively, against the US dollar. Furthermore, short positions across most regional equity markets translated into decent gains for managers, offsetting a portion of losses suffered from long exposure to the sector.
Coming into July, the underlying markets continue to trade in a fashion similar to last month’s. Equities continue to remain volatile and negative for the month-to-date, while in the commodity markets, a number of commodities are still trading at prices close to their respective record highs.
We continue to remain optimistic in terms of hedge fund performance, as the present state of the markets is likely to afford managers with profitable opportunities in time to come. For one, the already-oversold equity markets only seem to be sliding further down, thereby providing long/short managers with opportunities on the short side.
Secondly, persistent volatility which brings about some pricing inefficiencies in securities, works to the benefit of managers employing short-term strategies, such as arbitrageurs. Thirdly, crude oil prices are likely to increase further, given declining inventories and tensions in the Middle-East. An upward movement in crude would largely benefit CTAs, who have made a good portion of their gains from the commodity since 2007.
As far as the global macroeconomic picture goes, credit markets continue to appear stressed and inflation reports remain discouraging across most regions (partly because a slowdown in economic has been preventing many central banks from readily increasing interest rates adequately). Risk aversion continues to remain high among investors, owing to some extent, to the 2Q2008 earnings reporting season being just around the corner. It would be interesting to see what corporate earnings have been like over the last three months, and how much of a further (presumably negative) impact they may have on the underlying markets.
1 Based on 51% of the funds reporting the June 2008 returns as at 11 July 2008.