April Another Disappointing Month For Hedge Fund Performance

by Phillip Morton, Investors Offshore.com

10 May 2005

Hedge funds experienced another disappointing month during in April in terms of performance as two benchmark hedge fund indices, the Standard & Poor's Hedge Fund Index and the Van Global Hedge Fund Index both lost ground.

According to results published last week by S&P, seven out of nine hedge fund strategies, as measured by the S&P Hedge Fund Index (S&P HFI), were down in April as the S&P HFI lost 0.85% during the month.

The largest losses occurred in the S&P Directional/Tactical and S&P Arbitrage Indices as many of the factors that contributed to economic bullishness such as low inflation, surging corporate profitability and accommodative economic policy are now predicted to weaken from previous levels.

“Increased investor concern over financing conditions is producing a difficult investment environment for credit related securities,” noted Charles Davidson, Senior Hedge Fund Specialist at Standard & Poor’s. “S&P research shows a general trend in portfolios toward higher cash balances and a more defensive position higher in the capital structure.”

The S&P Directional/Tactical Index declined by 1.48% in April as all three of its broad underlying strategies, Macro, Managed Futures and Equity Long/Short, experienced varying levels of negative returns. Macro managers in April were impacted by range bound trading of energy prices, the decline in equity markets and uncertainty over the decoupling of the Chinese Yuan to the US dollar.

The S&P Managed Futures Index declined by 6.51% for the month as the majority of the assets in this strategy are managed by medium to long trend-followers who were adversely affected by several trend reversals. Gains in financial futures, especially those in Europe, were offset by losses in currency, energy and metals positions.

A decline in the majority of world equity markets, with the exception of Australia’s commodity driven market and a few others, negatively impacted equity long/short managers during the month. Small-caps, particularly in the United States, were hit the hardest in April. Small-cap performance is key to many managers in the space as they often search for long ideas in this less researched area of the capitalization range, while hedging market risk in the more liquid mid- and large-cap area. As a result, managers have begun to reduce their net market exposure. The net result, as indicated by the S&P Equity Long/Short Index, was a loss of 1.93% in April.

The S&P Arbitrage Index lost 0.61% in April led by poor performance in Convertible Arbitrage. Many managers in this strategy noted that this was the most difficult month in several years, but see opportunities for value-based investors as some bond names trade below fair value. The post GM spread blowout in high yield, which represents a high percentage of converts, also hurt valuations. Some fixed income managers profited from U.S. yield curve flattening trades, as weaker than expected GDP data and durable goods orders pushed interest rates down on the long end of the curve in the U.S.

The S&P Event-Driven Index lost 0.49% for the month as its three underlying strategies declined in April. Special Situations and Distressed were negatively impacted by a general widening of spreads and increased investor caution. Merger Arbitrage was negatively impacted by concerns over the ability of private equity and other financial buyers to access reasonable financing as spreads widened.

Meanwhile, a preliminary report by hedge fund advisor VAN showed that the Van Global Hedge Fund Index fell by 1.6% in April, net of fees.

"April continued a difficult period for hedge funds," noted George Van, Chairman of VAN. "Convertible arbitrageurs and long/short equity managers suffered the biggest losses in the month thus far. Outflows from convertible arbitrage have intensified, resulting in increased selling and depressed convertible prices. Following these losses, investors will likely continue to reduce their allocation to this strategy, putting further pressure on these managers over the short term. The loss of assets of such magnitude, however, often result in attractive opportunities over the long term."

However, Van points out that the major equity benchmarks experienced deeper losses last month. For example, The S&P 500 lost 1.9%, while the MSCI World Equity Index and the Dow Jones Europe Stoxx 50 fell 2.4% and 2.2%, respectively.

Also, hedge funds continue to outperform these benchmarks on a year-to-date basis. The Van Global Hedge Fund Index has a preliminary year-to-date return through April of -0.8% net while the S&P 500 sustained a 4.0% loss year to date through April. Both the MSCI World Equity Index and the Dow Jones Europe Stoxx 50 have sustained losses of 3.9% for the year.

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