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.
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