Hedge Funds Gain Ground In May

by Phillip Morton, Investors Offshore.com

08 June 2005

After a miserable first quarter, hedge fund investors had something to cheer about this week as performance data from three key hedge fund return trackers indicated that performance was largely positive during the month of May.

Five of the six hedge fund benchmarks covered by Dow Jones Hedge Fund Indexes posted gains for the month of May 2005. The merger arbitrage, equity long/short (US) and event driven strategies gained 1.06%, 0.93% and 0.53%, respectively. The equity market neutral and distressed securities strategies gained 0.40% and 0.21%. However, the convertible arbitrage strategy posted a loss of 2.50% for the month.

On a year-to-date basis, four of the six indexes were up – merger arbitrage (1.34%), distressed securities (0.43%), equity market neutral (0.29%) and event driven (0.25%). The convertible arbitrage and equity long/short (U.S.) strategies were down -9.18% and -2.57%, respectively.

Also reporting preliminary figures this week was Van Money Manager Research, LLC, with the Van Global Hedge Fund Index gaining 1.2% net of fees in May.

This compared to a mixed performance by the major equity benchmarks during the month: the S&P 500 and the MSCI World Equity Index gained 3.2% and 1.5%, respectively while the Dow Jones Europe Stoxx 50 fell 0.4%. The NASDAQ and Russell 2000 gained 7.6% and 6.4%, respectively.

For the year to date, hedge funds continue to beat those benchmarks. The Van Global Hedge Fund Index has a preliminary year-to-date return through May of 0.5% net while the S&P 500 sustained a 1.0% loss year to date through May. The MSCI World Equity Index, Dow Jones Europe Stoxx 50, NASDAQ, and Russell 2000 have lost 2.5%, 4.3%, 4.9%, and 5.4%, respectively, for the year.

"May saw a turnaround in hedge fund performance," noted Kevin Campbell, Vice President of VAN.

"On the strength of surging equity markets, particularly the NASDAQ and Russell 2000, long/short equity managers led the way. Macro managers also performed well in May," he observed.

However, Campbell added that convertible arbitrage continued its decline last month and he predicted that outflows from this sector are likely to continue in the coming months. He also noted that short-biased strategies struggled amid rising stocks.

Meanwhile, Standard & Poor's reported on Monday that the indicative S&P Hedge Fund Index (S&P HFI) rose 0.29% for the month of May.

Standard & Poor's analysis shows that hedge fund managers were able to capture a large portion of strong directional moves in global equity, bond and currency markets after experiencing small gains and losses for much of the month.

In addition, a rising global equity market that shook off the effects of the May 5th GM/Ford rating downgrade and mixed economic data, helped hedge fund performance in May, according to S&P. The largest gains in the index occurred among Managed Futures and Equity Long/Short managers.

The S&P Directional/Tactical Index advanced 1.00% in May as two of its three underlying strategies, Managed Futures and Equity Long/Short registered impressive gains. Macro managers were flat to slightly down as the focus in the marketplace shifted from China and its revaluation to the European Union and France's constitutional vote.

The S&P Managed Futures Index gained 2.43% in May with the majority of this return coming at the end of the month as managers benefited from a strong acceleration of the long USD/EUR trend. In addition, large gains were made in long financial futures positions as rates on the long end of the yield curve continued to decline.

"Some managers are becoming increasingly long US dollar vs. euro in part on the continued difficulty in passing the constitution in France and the Netherlands," explained Justin Dew, Senior Hedge Fund Specialist at Standard & Poor's.

"The long bias which hurt US equity managers in April, was beneficial in May as it allowed for the capture of gains in the surging equity markets," he observed, adding that:

"The historically low net exposure of European funds, combined with profit taking earlier in the month, prevented European managers from seeing the same level of gains as found in the United States."

Dew also notes that managers in Asia had a more difficult time as the Nikkei 225 dropped during the first half of the month before rising during the second. The net result, as indicated by the S&P Equity Long/Short Index, was a gain of 0.87% in May.

The S&P Arbitrage Index declined 0.22% during the month of May, led lower by losses in Convertible Arbitrage. However, despite recent losses, some managers believe a bottom is near as valuations and slowing redemptions are making the strategy attractive again for many sophisticated investors.

The Equity Market Neutral strategy, which faced a situation similar to Convertible Arbitrage of low absolute returns and large outflows last year, continues to generate strong year-to-date alphas, a measure of risk-adjusted performance.

In the Fixed Income Arbitrage sector, performance continues to rank highly among the best performing strategies through May with yield curve flattening trades a big contributor to its return.

The S&P Event-Driven Index gained 0.12% in May as managers benefited from a tightening of credits spreads in the U.S. market. Special Situations and Merger Arbitrage both showed strong correlations to the market, as rising equity markets typically increase the probability of a profitable exit strategy from positions.

"Spin-offs/mergers and restructurings are more likely to happen as the economic environment improves in the US," stated Dew.

"Some managers in this space are also see increasing opportunities in Europe as it appears likely that rate cuts will occur and private equity investment are on the rise," he added.

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