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Hennessee: Hedge Funds Protect Capital as Markets Decline

New York (HedgeCo.net) – The Hennessee Hedge Fund Index declined -0.54% in May (+2.86% YTD), while the S&P 500 declined -1.35% (+6.97% YTD), the Dow Jones Industrial Average fell -1.88% (+8.56% YTD), and the NASDAQ Composite Index decreased -1.33% (+6.87% YTD). Bonds advanced, as the Barclays Aggregate Bond Index increased +1.31% (+3.04% YTD) and the Barclays High Yield Credit Bond Index advanced +0.49% (+6.01% YTD).

“Most hedge funds lost money in May as risk assets experienced a sharp reversal due to concerns about the global economic recovery. Commodities took the biggest hit, with silver declining -21% and oil falling -10% during the month,” commented Lee Hennessee, Managing Principal of Hennessee Group . “Hedge funds were positioned defensively, which allowed them to protect capital during the sell off. Several managers used the sell off to add to high conviction core positions and reduce higher beta names.”

“From a macro perspective, we expect volatility to continue this summer as the US Federal Reserve intends to end the second round of quantitative easing (QE2) at the end of June,” commented Charles Gradante . “In addition, investor sentiment is pretty bearish as they are focusing on the renewed concerns about the European sovereign debt problems, weak U.S. and global economic data, and rising inflation in China , which are all contributing to greater volatility. This is a very challenging investment environment for stock pickers.”

Despite a solid earnings season and ongoing accommodative monetary policies, the equity markets experienced broad based losses during the month of May as economic growth concerns and the sovereign debt crisis once again dominated the headlines and resulted in investors fleeing risk assets. The S&P 500 Index lost -1.35% during the month (+6.97% YTD), its worst monthly loss since August 2010.

Large-cap stocks slightly outperformed small caps stocks in May as the Russell 2000 Index slid -1.9% (+8.7% YTD) after reaching a new all time high during the month of April. From a sector perspective, four out of the ten sectors experienced gains. The defensive oriented health care sector continued to outperform as investors became more risk averse and fled the more cyclical oriented sectors, most notably the energy sector which fell -4.6% for the month (+12.6% YTD). Managers were able to generate some gains with short positions and hedges, while losses on the long side of portfolios offset most gains. The Hennessee Long/Short Equity Index ended the month roughly flat, -0.09% (+4.01%).

The best performing funds were characterized by having flat or negative net exposure levels or in the healthcare and biotech sector. Managers remain constructive on the outlook for 2011 due in large part to the solid earnings reports, ongoing accommodative policies and reasonable valuations. That said, they are cautious as sovereign debt problems, geopolitical unrest, and a struggling jobs and housing market continue to present legitimate near term risks to equities.

The Hennessee Arbitrage/Event Driven Index declined -0.71% in May (+2.69% YTD). Despite falling equity markets, credit markets were resilient, as the Barclays Aggregate Bond Index increased +1.31% (+3.04% YTD) and the Barclays High Yield Credit Bond Index advanced +0.49% (+6.01% YTD). Treasuries and investment grade credit benefited from a flight to quality, gaining +2.6% and +1.5%, respectively. Yields on junk bonds fell to an all-time low of 6.75% mid-May, before increasing due to negative economic data, weaker equities, and record new-issuance volumes and ending the month at 6.92%. Spreads over Treasuries widened to 538 basis points, their widest level since late March. The Hennessee Distressed Index declined -0.00% in May (+6.16% YTD). Managers experienced gains on several event driven positions, but were negatively affected by a flight to quality, weak equity markets and wider credit spreads. Several managers used the sell off to add to high conviction core positions and reduce illiquid or higher beta names. The Hennessee Merger Arbitrage Index declined -0.00% in May (+3.37% YTD). Merger arbitrage managers suffered losses as deal spreads widened. However, M&A activity continued with Teva announcing a proposed takeover of Cephalon, Conagra announcing a bid for Ralcorp, Volkswagon attempting to acquire a stake in MAN SE, and International Paper bidding for Temple-Inland. Managers are dedicating more resources to identifying takeover targets hoping that the positions get taken out at a premium. With interest rates low, easy access to financing, and balance sheets flush with cash, companies are expected to remain in M&A mode for the foreseeable future. The Hennessee Convertible Arbitrage Index returned -0.18% (+3.83% YTD) in May.

“As several European countries undergo significant changes and struggle with debt levels and economic growth, managers are becoming more interested in European distressed opportunities,” commented Charles Gradante . “However, while many believe there will be a significant opportunity set, we are still early in the cycle, and the best opportunities are not going to emerge until maybe next year.”

The Hennessee Global/Macro Index declined -1.16% in May (+0.46% YTD). During the month, global markets sold off due to increased concern about the sustainability of the global recovery and the possibility of an outright default by Greece . In addition, there was disappointing data in Europe and China . China remains a key focus for managers as a hard landing would certainly have negative global consequences. The MSCI EAFE Index fell -3.6% (+4.5% YTD), while the MSCI Emerging Markets Index declined -3.0%. Hedge funds posted losses, albeit less than traditional benchmarks, with the Hennessee International Index falling -1.55% (+1.32% YTD) and the Hennessee Emerging Market Index declining -0.85% (+2.58% YTD). The Hennessee Macro Index fell -1.95% for the month (-1.42% YTD). Macro managers were affected by declines in commodity and equity markets, and continued weakness in European fixed income markets. The key macro theme in May was a sharp reversal of the “risk on” trade. The U.S. Dollar Index strengthened +2.3%, putting downward pressure on risk assets. Commodities were the key detractor in May as the S&P GSCI Commodities Index fell -6.89% (+8.46% YTD), notably silver (-21%) and oil (-10%). While gold prices were under pressure during the first week of the month, it recovered most its losses to end the month down -1.3%. Managers remain bullish on gold as central banks continue to print money. Agricultural commodities also declined, though were down significantly more mid-month.

Editing By Alex Akesson

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One Response to Hennessee: Hedge Funds Protect Capital as Markets Decline

  1. comentor says:

    your YTD numbers can’t possibly be correct.

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