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Best Gains For Hedge Funds Since 1999

New York (HedgeCo.net) – “Hedge funds experienced their best year since 1999 and were able to perform in line with the traditional equity markets in 2009 despite the strong rally and moderate net exposure,” said Mr. Gradante, Managing Principal of Hennessee Group LLC, a consultant and adviser to direct investors in hedge funds, “The top three performing strategies in 2009 included convertible arbitrage, emerging markets and distressed. Of these, we are particularly bullish in distressed in 2010 due to enormous opportunities still remaining and yet to come.”

“In addition to strong gains, we were encouraged by the slow down in redemptions and fund closures, particularly as the year progressed, and are now beginning to see net inflows and an uptick in fund launches,” said E. Lee Hennessee , Managing Principal of Hennessee Group. “We believe the industry has put the worst behind it, and is well positioned entering 2010.”

The Hennessee Hedge Fund Index gained +24.6% in 2009, while the S&P 500 advanced +24.7%, the Dow Jones Industrial Average returned +18.8%, and the NASDAQ Composite Index jumped +43.9%. Bonds also experienced broad based gains as the Barclays Aggregate Bond Index rose +5.9%, while the Merrill Lynch High Yield Master II Index gained an impressive +57.5%.

The top two performing hedge fund strategies for the year were convertible arbitrage and distressed funds. Managers were able to take advantage of the massive deleveraging and forced liquidations as a result of the credit crisis in 2008 and purchase securities at very attractive valuations earlier in the year.

The Hennessee Convertible Arbitrage Index, advanced +39.9%, its best year on record. Convertible bond funds benefited from elevated levels of volatility and a significant contraction in credit spreads throughout the year.

“With the S&P 500 Index trading at a multiple of approximately 23x, the equity markets appear to be pricing in strong earnings growth and a V-shaped economic recovery in 2010,” said Mr. Gradante. “We believe momentum may have carried the equity markets too far in 2009 and at current levels, appear a bit frothy. If earnings or economic growth disappoint, we could see a near term correction. In addition, we anticipate fundamentals to be under greater scrutiny in 2010 which should lead to large performance dispersions among stocks and sectors. This should prove to be a favorable environment for long/short equity funds.”

The Hennessee Long/Short Equity Index advanced +21.7% in 2009. After plunging nearly -60% from its high in October-2007 through early March-2009, the equity markets experienced a strong, broad based rally, gaining over +65% during the final nine months of the year. Long/short equity funds profited from positions in their long portfolios while short portfolios and hedges generally served as a drag on performance. Shorting was particularly difficult as some of the top performers for the year were low quality, cheap stocks.

Growth stocks outperformed value with the Russell 3000 Growth Index gaining +37.0% in 2009 while the Russell 3000 Value Index advanced +19.8%. From a sector perspective, technology stocks led the way with a +59.9% gain, followed by material stocks (+45.2%) and consumer discretionary stocks (+38.8%). Hedge funds most willing to take on heightened directional risk while buying up high beta stocks that experienced the steepest sell-offs during the credit crisis were most rewarded while those funds that remained defensively positioned, and cautious, with an emphasis on fundamentals, generally lagged, particularly as the year progressed. Short biased managers suffered in 2009 as the Hennessee Short Biased Index declined -17.5%.

“Hennessee Group’s discussions with hedge fund managers conclude that it is illogical to believe that there will be a dollar rebound in 2010 due to material improvement in the U.S. fiscal or monetary conditions. Rather, any rallies in 2010 will be due to the decline in the euro resulting from EU sovereign risk,” commented Mr. Gradante. “The dollar has been the primary beneficiary of Fitch and Standard & Poor’s credit rating downgrades of E.U. member Greece, and similar worries about Portugal, Spain and Ireland. Furthermore, in 2010 our research indicates that managers expect the bond market to lead the Fed to raise rates.”

The Hennessee Global/Macro Index advanced +24.6% in 2009. The international equity markets participated in the broad based market rally, led by the Emerging Markets, particularly China . The Hennessee International Index advanced +21.4% for the year, while the Hennessee Emerging Markets Index returned +39.1%.

The MSCI EAFE rose +27.8%, while the MSCI Emerging Markets Index jumped +74.5% and the Shanghai SE Composite Index leaped +79.9%. The Chinese equity markets benefited from a favorable economic outlook due to unprecedented government support and a general belief the country will lead the global economy out of recession. Another area of strength in 2009 was Latin America as the MSCI EM Latin American Index gained a strong +98.1% for the year, led higher by Brazil. While macro funds lagged the majority of strategies in 2009, the Hennessee Macro Index still managed to produce a respectable gain of +13.1% for the year.

Popular themes for macro managers in 2009 included short positions in the U.S. dollar and treasuries, and long positions in oil and gold. In addition, macro managers took advantage of historically low rates, particularly in the U.S, to profit from the carry trade. The S&P Crude Oil Spot gained +77.9% for the year after selling off steeply in late 2008 while gold reached an all-time high crossing over $1,200 in November of 2009.

“The carry trade is likely to remain a popular theme in 2010 among macro managers as policymakers hold rates at historically low levels in developed countries to further spur economic growth while inflation leads to rate hikes in emerging market and commodity-driven economies,” stated Mr. Gradante. “We also believe gold and other precious metals will remain a substantial allocation for hedge funds as a hedge against longer term inflation.”

Editing by Alex Akesson
For HedgeCo.net
alex@hedgeco.net
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