Hedge Funds Edge Ahead In March

by Carla Johnson, Investors Offshore, London

22 April 2003

The Hennessee Hedge Fund Advisory Group, a global hedge fund investment consulting firm which advises individuals and institutions on over $1 billion in assets, has announced that hedge funds produced a positive return of 0.62% in March, bringing the year to date return to +1.09%, according to the Hennessee Hedge Fund Index. The broad market indices also rallied in March, with the S&P 500 Index gaining +1.00% (down -3.15% YTD) and the Dow Jones Industrial Average increasing +1.28% (down -4.19% YTD). The Nasdaq Index was up +0.27% (up 0.43% YTD).

"Credit spreads narrowed impressively preceding the war and have continued through March, with hedge funds in the High Yield sector benefiting the most from this contraction," said Charles Gradante, Managing Principal of Hennessee. "Greenspan’s monetary easing is helping balance sheet issues among lower credits," added Mr. Gradante.

The Hennessee Latin America Index was March’s top performer with a return of +8.20% (+5.04% YTD), bouncing from the position of being February’s worst performing strategy. The second best performer for the month was the High Yield Index, with a return of +2.43% (+6.70% YTD). In third position was the Healthcare and Biotech Index, posting a return of +2.34% (+1.43%YTD) for March. The Pacific Rim Index posted a –1.67% (-2.65%) return in March, the worst performing strategy for the month.

Hennessee also recently unveiled the findings for its 9th Annual Hennessee Hedge Fund Manager Survey, indicating that the hedge fund industry grew 5% in 2002 to a total of $592 billion through manager performance and new capital inflows. Hedge funds outperformed the broader equity markets in 2002 as the Hennessee Hedge Fund Index® declined -3.43% net of fees, bringing the annualized return since January 1987 to 15.28%, versus the S&P return of 11.07% over the same time period.

"The year 2002 was the most difficult market for stock pickers and traders alike since 1974; certainly the most difficult year for hedge funds on record," stated Mr Gradante. "2002 presented paradigm shifts in money management that handcuffed most hedge fund managers. Nonetheless, hedge funds did preserve capital in 2002 and are well positioned, with high amounts of cash, for the economic turnaround expected in the fourth quarter of 2003 and an election year in 2004."

Hedge funds were able to avoid serious losses by holding high levels of cash, positioning their portfolios defensively, and maintaining low market exposure. In 2002, the average hedge fund net market exposure was +33%, the lowest in Survey history. Individuals/family offices remained the largest source of capital for hedge funds, contributing 42% ($249 billion) of total assets. However, their market share has continued to decline from 80% ($79 billion) of total assets in 1994. Fund-of-funds were the second largest source of capital (27% of assets).

"Our greatest concern continues to be the ability of the industry to absorb the incoming money flow without diluting the talent pool and thus hurting performance," notes E. Lee Hennessee, Managing Principal of the Hennessee Group. "However, most managers seem to have a good sense of their capacity limits, as the survey indicates."

The tendency of hedge funds to hold large amounts of cash may reduce risk, but in the eyes of many investors it defeats the purpose of making hedge fund investments in the first place. According to Horizon Cash Management LLC in Chicago (one firm that definitely does benefit from the hedge funds' cash retention policy), hedge funds held about 33% of their assets in cash on average at the end of the first quarter, up from 23% at the end of 2002 and 17% at the end of 2001.

Horizon says it knows of funds with cash positions over 65% which are effectively operating as funnels for cash which ends up being managed by Horizon - currently the firm has more than $1bn under management.

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