9 Aug 2010
Hennessee Group has announced that the Hennessee Hedge Fund Index advanced +1.91% in July (+1.86% YTD), while the S&P 500 increased +6.88% (-1.21% YTD), the Dow Jones Industrial Average climbed +7.08% (+0.36%), and the NASDAQ Composite Index advanced +6.90% (-0.64% YTD). Bonds advanced, as the Barclays Aggregate Bond Index increased +1.07% (+6.46% YTD).
The Hennessee Long/Short Equity Index advanced +1.81% in July (+1.22% YTD). The U.S. equity markets rallied in July, experiencing their best month in a year, on better-than-expected corporate earnings. The top performing sectors were materials (+12.2%), industrials (+10.3%) and energy (+8.0%). The healthcare sector was the worst performing sector in July, up only +1.3%, and is the worst performing sector year to date, down -7.6%. Long/short funds lagged equity markets during the broad-based rally, due to low net exposure levels and losses experienced in short portfolios. Thus far this year, stock picking has been challenging with the main issue being the very high correlations in stocks and sectors. Periods of high correlation are not uncommon, but are temporary. They also produce opportunities as fundamentals become misaligned with prices. Since many hedge funds rely on fundamental bottom-up research, the recent market, which has been dominated by macro themes, has been difficult. As second quarter earning reports were released, the markets started to respond more to fundamentals, allowing managers to generate alpha. This should hopefully bode well for an improvement in long/short equity performance during the second half of the year.
The Hennessee Arbitrage/Event Driven Index advanced +2.06% in July (+4.51% YTD). Arbitrage and event driven managers posted gains as volatility declined, liquidity improved, equity markets rallied, and credit spreads tightened. During the month, the spread on the BofA Merrill Lynch U.S. High Yield Index tightened from 713 basis points to 657 basis points. Managers remain selectively optimistic in credit as high yield spreads remain wider than historical averages, default rates are expected to decline significantly, corporate balance sheets are greatly improved, and low interest rates are driving increased inflows into high yield. The Hennessee Distressed Index increased +1.75% in July (+6.05% YTD). Distressed funds benefited from their net long bias and experienced a rebound after sell offs in the two previous months. While low interest rates are allowing many companies to refinance and otherwise avoid bankruptcy, there remain many over-leveraged companies that will struggle in a muted growth economic environment. In addition, managers are looking towards 2012 to 2015 when $1 trillion in high yield and leveraged loan securities are scheduled to mature. The Hennessee Merger Arbitrage Index advanced +0.80% in July (+2.41% YTD). During the sell off in May and June, previously unattractive spreads on quality deals widened to attractive levels, with the average deal spread reaching 10% to 12% at the beginning of July. Managers added to core positions in June and benefited as stocks rebounded in July. In addition, deal activity has accelerated, with more than $90 billion in announced deals during the last few weeks. Managers remain optimistic due to large amounts of cash on corporate balance sheets (over $1 trillion), large amounts of investable cash at private equity firms (over $500 million), and low interest rates, which allows companies to raise capital cheaply. The Hennessee Convertible Arbitrage Index advanced +2.69% (+3.03% YTD) in July. Managers are relatively optimistic on convertible arbitrage as the May-June sell off created attractively priced opportunities. Corporate credit remains stable as companies have built defensive cash balances and have reduced leverage on balance sheets. In addition, the low-interest rate environment allows funds to utilize leverage and enhance the positive carry on portfolios. Volatility is also elevated, which provides trading opportunities for hedge funds.
The Hennessee Global/Macro Index increased +1.92% in July (+0.29% YTD). After three months of losses, international equities reversed course in July and experienced a sharp rally as the MSCI EAFE Index advanced +9.41% (-6.70% YTD). During the month, European stocks performed well after favorable results from bank stress tests, with the MSCI Europe Index increasing +11.54% (-8.97% YTD). Hedge funds lagged due to conservative portfolios, as the Hennessee International Index advanced only +1.77% (-0.48% YTD). The Hennessee Macro Index declined –0.60% for the month (-0.26% YTD). Managers experienced losses short equities and commodities, which were partially offset by gains in fixed income. In currencies, hedge funds short the Euro suffered losses as the Euro continued its sharp rally against the U.S. dollar, increasing +6.6% in July. As investors increased risk appetites, the U.S. dollar also declined against the British Pound and the Yen. In fixed income, the U.S. yield curve flattened as the 30 Year Treasury sold off, providing profits for managers short the long-end of the curve. Managers lost money long gold and silver, while generating profits on oil. Many also experienced losses short U.S. equities, but remain bearish and are positioning portfolios for a decline after second quarter earnings.
“Hedge fund managers lagged the broader markets due to defensive portfolio positioning. Managers began July with lower than average exposures after significantly reducing gross and net exposure levels during May and June. As a result, hedge funds lagged as equity markets rose sharply,” said Lee Hennessee, Managing Principal of Hennessee Group. “On a positive note, we are encouraged to see that performance was partially driven by stock selection, rather than only directional market exposure. Stocks started to respond more to fundamentals as quarterly earnings were reported, a constructive development for hedge funds.”
“The economy is at an inflection point. Leading economic indicators are peaking with no real improvement in employment,” commented Charles Gradante, Co-Founder of Hennessee Group. “A double dip recession remains a possibility, but most managers feel that it is more likely that the U.S. economy experiences an extended period of slow growth due to weak consumption, withdrawal of fiscal stimulus and continued deleveraging. Several have referred to this as the ‘New Normal’. This would likely lead to financial markets being range bound, which should be a somewhat favorable environment for stock selection and for hedge funds.”
The Hennessee Long/Short Equity Index advanced +1.81% in July (+1.22% YTD). The U.S. equity markets rallied in July, experiencing their best month in a year, on better-than-expected corporate earnings. The top performing sectors were materials (+12.2%), industrials (+10.3%) and energy (+8.0%). The healthcare sector was the worst performing sector in July, up only +1.3%, and is the worst performing sector year to date, down -7.6%. Long/short funds lagged equity markets during the broad-based rally, due to low net exposure levels and losses experienced in short portfolios. Thus far this year, stock picking has been challenging with the main issue being the very high correlations in stocks and sectors. Periods of high correlation are not uncommon, but are temporary. They also produce opportunities as fundamentals become misaligned with prices. Since many hedge funds rely on fundamental bottom-up research, the recent market, which has been dominated by macro themes, has been difficult. As second quarter earning reports were released, the markets started to respond more to fundamentals, allowing managers to generate alpha. This should hopefully bode well for an improvement in long/short equity performance during the second half of the year.
“One of the primary concerns of hedge funds is related to income tax and regulatory policy. Recent regulatory action is considered by most managers to result in a drag on future GDP growth,” commented Charles Gradante. “In addition, the regulatory environment has also proven to be extremely unpredictable causing reduced appetite for risk. Hedge fund managers historically have reduced exposures when they have less clarity in fiscal and monetary policies. The current environment is prompting funds to be defensive, with managers closely monitoring the political landscape and the November elections.”
The Hennessee Arbitrage/Event Driven Index advanced +2.06% in July (+4.51% YTD). Arbitrage and event driven managers posted gains as volatility declined, liquidity improved, equity markets rallied, and credit spreads tightened. During the month, the spread on the BofA Merrill Lynch U.S. High Yield Index tightened from 713 basis points to 657 basis points. Managers remain selectively optimistic in credit as high yield spreads remain wider than historical averages, default rates are expected to decline significantly, corporate balance sheets are greatly improved, and low interest rates are driving increased inflows into high yield. The Hennessee Distressed Index increased +1.75% in July (+6.05% YTD). Distressed funds benefited from their net long bias and experienced a rebound after sell offs in the two previous months. While low interest rates are allowing many companies to refinance and otherwise avoid bankruptcy, there remain many over-leveraged companies that will struggle in a muted growth economic environment. In addition, managers are looking towards 2012 to 2015 when $1 trillion in high yield and leveraged loan securities are scheduled to mature. The Hennessee Merger Arbitrage Index advanced +0.80% in July (+2.41% YTD). During the sell off in May and June, previously unattractive spreads on quality deals widened to attractive levels, with the average deal spread reaching 10% to 12% at the beginning of July. Managers added to core positions in June and benefited as stocks rebounded in July. In addition, deal activity has accelerated, with more than $90 billion in announced deals during the last few weeks. Managers remain optimistic due to large amounts of cash on corporate balance sheets (over $1 trillion), large amounts of investable cash at private equity firms (over $500 million), and low interest rates, which allows companies to raise capital cheaply. The Hennessee Convertible Arbitrage Index advanced +2.69% (+3.03% YTD) in July. Managers are relatively optimistic on convertible arbitrage as the May-June sell off created attractively priced opportunities. Corporate credit remains stable as companies have built defensive cash balances and have reduced leverage on balance sheets. In addition, the low-interest rate environment allows funds to utilize leverage and enhance the positive carry on portfolios. Volatility is also elevated, which provides trading opportunities for hedge funds.
“Hennessee Group remains concerned over the Treasury market bubble. Besides the end of 2008, the 10 Year Treasury has not been below 3.00% since the 1950s. Nonetheless, macro managers continue to lose money on bearish Treasury Yield Curve bets,” commented Charles Gradante. “In addition, the spread between the 10 and 30 Year Treasury has widened to 110 basis points, near a historical high. For the first time in many years, managers and the Hennessee Group are talking about the possibility of a ‘hockey stick’ yield curve. The Fed is likely to keep the 10 Year Bond low to assist the housing market while financing its deficit in the 20/30 year sector.”
The Hennessee Global/Macro Index increased +1.92% in July (+0.29% YTD). After three months of losses, international equities reversed course in July and experienced a sharp rally as the MSCI EAFE Index advanced +9.41% (-6.70% YTD). During the month, European stocks performed well after favorable results from bank stress tests, with the MSCI Europe Index increasing +11.54% (-8.97% YTD). Hedge funds lagged due to conservative portfolios, as the Hennessee International Index advanced only +1.77% (-0.48% YTD). The Hennessee Macro Index declined –0.60% for the month (-0.26% YTD). Managers experienced losses short equities and commodities, which were partially offset by gains in fixed income. In currencies, hedge funds short the Euro suffered losses as the Euro continued its sharp rally against the U.S. dollar, increasing +6.6% in July. As investors increased risk appetites, the U.S. dollar also declined against the British Pound and the Yen. In fixed income, the U.S. yield curve flattened as the 30 Year Treasury sold off, providing profits for managers short the long-end of the curve. Managers lost money long gold and silver, while generating profits on oil. Many also experienced losses short U.S. equities, but remain bearish and are positioning portfolios for a decline after second quarter earnings.
