Hedge Funds Outperform Equities In February

by Phillip Morton, Investors Offshore.com

12 March 2008

The Hennessee Group LLC, an adviser to hedge fund investors, has announced that, while US equity markets sank last month, the Hennessee Hedge Fund Index managed a return of 1.28% in February.

The Hennessee index remains down by 1.43% year-to-date, but has outperformed the S&P 500 index by nearly 8% over the same timeframe, the company stated in its monthly performance update.

The Index also outperformed the major US equity benchmarks in the month of February, including the S&P 500, which declined by 3.48%, the Dow Jones Industrial Average, which fell by 3.03%, and the NASDAQ Composite Index, which dropped by 4.95%.

However, while it was a reasonable month for long/short equity funds in February, E. Lee Hennessee, Managing Principal of Hennessee Group, observed that it continues to be "an extremely difficult market for fixed income funds”.

“Several fixed income focusing on investment grade mortgages and municipal bonds have recently faced margin calls and been forced to unwillingly sell assets," Hennessee noted.

The Hennessee Long/Short Equity Index advanced 0.93% in February, but it remains down 2.44% YTD.

According to the Hennessee Group, whereas equity market volatility proved difficult to navigate in January, funds were able to benefit from the increase in volatility in February. Short portfolios acted as a better hedge in February, providing protection from the market’s decline, the company noted.

“It’s likely that AIG’s write-off within its credit default swap portfolio will be followed by similar write-offs by many of the large banks,” explained Charles Gradante, Managing Principal of Hennessee Group.

He continued:

“Banks may have another USD200 billion to write-off as the result of being on the wrong side of this trade if they mark-to-market these contracts. Furthermore, the commercial real estate market is showing signs of weakness due to over-levered real estate investors.”

The Hennessee Arbitrage/Event Driven Index advanced 0.34% in February (down 1.11% YTD) and the Distressed Index advanced 0.79% for the month (down 2.07% YTD), but the Merger Arbitrage Index declined 0.56% for the month, (down 3.32% YTD), and the Convertible Arbitrage Index declined 0.56% in February, (up 0.08% YTD).

The Hennessee Group explained that:

"While spreads widened in most areas of corporate debt, many credit oriented funds posted positive returns as yields have started to reach attractive levels to compensate for widening spreads. Several small companies filed for bankruptcy and most expect more defaults in the coming months."

"While strategic merger and acquisition activity picked up with several high profile hostile deals in the technology and commodity sectors, merger spreads were generally weaker throughout the month because of high equity volatility. Hung LBO deals are slowly being completed although most continue to have difficulty obtaining attractively priced financing."

"Despite the market’s sell off, implied volatility as measured by the VIX was virtually flat for the month while credit spreads widened. Many funds are starting to find more attractive opportunities within convertibles as a result of the strategy’s poor performance in 2007."

One of the strongest performers last month was the Hennessee Global/Macro Index, which advanced 2.55% in January (down 0.46% YTD).

Gradante observed that: “Macro managers are diversifying their agricultural portfolios to include major positions in sugar because, on an inflation adjusted basis, sugar is the cheapest commodity and more cost effective than corn in producing ethanol."

The Hennessee International Index returned 2.51% (-1.44% YTD), coinciding with gains in both the MSCI Europe and MSCI Asia-Pacific Index.

Some of the best returns last month were captured by the Hennessee Macro Index, which posted a gain of 3.92% (up 5.88% YTD).

According to Hennessee's analysis, macro strategy gains were brought about because commodities (especially oil, gold, platinum, grains) were strong throughout the month, the US yield curve steepened, the US dollar weakened versus both the euro and the yen, and emerging market equities outperformed US equities.

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