West Palm Beach (HedgeCo.net) – Morningstar, Inc. reported that hedge funds reported the worst losses in the Morningstar Hedge Fund Index’s history, which began in January 2003.

In September, the Morningstar 1000 Hedge Fund index dropped 7.87%, more than double August`s losses. Hedge funds entered the third quarter virtually flat for the year, but the index`s 13.17% third-quarter drop dragged year-to-date performance into the red.

"In September, the financial world as we know it turned upside down. We saw a shakeout in the hedge fund industry all around the globe. Hedge funds experienced poor borrowing, hedging, and trading conditions while liquidity dried up and volatility skyrocketed," said Morningstar hedge fund analyst Nadia Van Dalen.

Hedge funds were affected by extreme and unforeseen events during the month, including failures and takeovers of mortgage agencies, banks, insurers, and prime brokers.

As the world watched in anticipation of a U.S. government bailout, the global equity markets roiled. The Morningstar Global Equity Hedge Fund Index lost 11.22% in September. The Morningstar Europe Equity Hedge Fund Index declined 9.62% during the month but outperformed the MSCI Europe Index by more than five percentage points, while the Morningstar US Equity Hedge Fund Index underperformed the SandP 500 Index by more than one percentage point.

Developed Asia and emerging markets equity hedge funds managed to avoid some of the market losses, as these indexes outperformed the MSCI AC Asia Index and the MSCI Emerging Markets Index by about five percentage points in September. For the year to date, however, these emerging markets funds have taken more than a 30% hit.

Hedging proved difficult for hedge funds this month. The SEC and the FSA announced temporary bans on shorting financial stocks. Many convertible arbitrage funds taking long positions in financial sector convertible bonds were unable to hedge with short stock positions. The Morningstar Convertible Arbitrage Hedge Fund Index lost 12.39% in September. Fortunately, some equity arbitrage hedge funds were able to avoid financials. The Morningstar Equity Arbitrage Hedge Fund Index lost only 4.60%.

Debt-oriented hedge funds also experienced hedging problems. Credit default swaps, a common way to hedge bond exposure, became more expensive and less attractive with fears of default and counterparty risk. Both the Morningstar Debt Arbitrage and the Morningstar Global Debt Hedge Fund Indexes underperformed global and U.S. bonds, losing 4.39% and 7.50% respectively. The Morningstar Distressed Securities Hedge Fund Index closed the month down 6.21% as risky debt yields rose.

Global trend following hedge funds actually profited from some of the downward trends in the market, as these funds trade stock index futures as well as interest rates, currencies, and commodities. The Morningstar Global Trend Hedge Fund Index lost only 1.26% in September, the best-performing category other than short equity. The Morningstar Global Non-trend Index, comprised of funds with a more macro-economic approach, slid only 1.56%.

Funds of funds performed in line with the Morningstar 1000 Hedge Fund Index, outperforming the index by about 20 basis points in September, but falling slightly short for the quarter and year to date. The Morningstar Multistrategy Hedge Fund Index underperformed the overall index by about 200 basis points in September.

Alex Akesson

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Email: alex@hedgeco.net

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West Palm Beach (HedgeCo.net) – The Morningstar 1000 Hedge Fund Index lost 3.12% in August, significantly underperforming U.S. and global equity and bond markets.

August, like July, was characterized by a large drop in emerging markets and commodities. "Even though commodity prices have started to descend, their lofty valuations slowed growth and demand, especially in emerging markets,” said Morningstar Hedge Fund Analyst Nadia Van Dalen. "It was only a matter of time before hedge funds riding these waves crashed."

The Morningstar Emerging Markets Hedge Fund Index lost 7.13% in August while the Global Trend Hedge Fund Index, which profited from a previous upward trend in commodities, lost 5.35%. Both of these indexes experienced similar losses in July. Through July however, these funds continued to receive the largest inflows of assets this year, approximately $10.9 billion.

Unlike emerging market hedge funds, U.S. equity hedge funds fared relatively well. The Morningstar US Equity Hedge Fund Index earned 0.47% in August. Even though these hedge funds performed better than those in other equity categories, they still underperformed the markets—the S&P 500 Index gained 1.45% in August. Similarly, the Morningstar US Small Cap Equity Hedge Fund Index lost 2.81% while the Russell 2000 Index gained 3.61%

The U.S. equity markets were propped up for most of the month by the rising dollar and weakening Euro. Morningstar calculates its hedge fund indexes by converting hedge fund returns into U.S. dollars using the spot rate at the end of the month. This methodology does not hedge U.S. dollar exposure, and reflects the negative impact of Euro-denominated funds.

Along with the Euro, European equity markets dropped in August, reacting to weak economic data. The Morningstar Europe Equity Hedge Fund Index dropped 3.33%. Year to date through July 31, funds in this index have seen the largest outflows, approximately $9.6 billion. Despite the appreciation of the Yen, developed Asian equity markets followed that of emerging markets in general. The Morningstar Developed Asia Equity Hedge Fund Index lost 3.10%. Currency traders on the right side of the dollar, Yen, and Euro trades helped to cushion the blow for the Global Non-trend Hedge Fund Index, which lost 1.63%.

Global bonds, as measured by the Lehman Global Aggregate index ended the month in the red, and the Morningstar Global Debt Hedge Fund Index and the Morningstar Debt Arbitrage Hedge Fund Index both experienced losses of 3.64% and 1.33%, respectively. During the month, credit spreads widened amid financial distress at Fannie Mae and Freddie Mac, hurting funds in these indexes. Volatility in the credit markets also affected funds in the Morningstar Convertible Arbitrage Hedge Fund Index, which lost 1.08%.

Distressed securities funds and corporate event funds continued to wait for a market turn around. The Morningstar Distressed Securities Hedge Fund Index and Corporate Actions Hedge Fund Index dropped 1.28% and 2.34%, respectively. Multi-strategy funds outperformed hedge funds of funds. These indexes fell 2.40% and 3.99%, respectively.
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CNBC – Returns are meager or negative, capital flows are slowing and hedge funds appear to be folding at a record rate; so monied investors might be prompted to ask … who needs a hedge fund anyway? 

“Institutions have taken over the hedge fund space," says Morningstar analyst Nadia Van Dalen, adding they are intrinsically better able to identify the best-performing funds and then pour money into them. “The high net worth investor is at a worse disadvantage now [than in the past].”

So much for letting the individual investor play with the Big Boys.

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