Hedge Funds Negative Peformance | August Returns Lag

Negative Performance

Hedge Funds Negative Peformance

Something very odd has happened in global hedge funds in August 2007, with widespread negative returns across a range of investment strategies. Is there something rotten in the woodshed or is it mere coincidence?

Not surprisingly, hedge funds with direct exposure to the US sub-prime market or significantly impacted by the resulting blow-out in credit spreads, delivered negative returns in August 2007. Also not surprising given the adverse move in credit spreads, broader fixed income hedge fund strategies declined, such as represented by Cogent Hedge's Fixed Income Index (-1.0% in August 2007 after declining 0.1% in July 2007).

However, what is surprising is that in a month when global sharemarkets were broadly flat to up (MSCI World Index 0.0%, S&P500 +1.3%), declines in hedge fund strategies were widespread.

The following summarises the results of key hedge fund index providers in August 2007:

• Cogent Hedge All Funds Index declined in August (-1.8%), and ALL 10 Cogent's sub-groupings also delivered negative returns;
• Credit Suisse|Tremont Hedge Fund Index declined (-1.5%) and ALL 13 sub-groupings declined;
• Eurekahedge Hedge Fund Index declined (-1.8%) along with ALL 10 sub-groupings. The Eastern Europe & Russia HF Index declined (-3.2%);
• Hedge Fund Research Composite Index declined (-1.3%) and 12 out of 13 sub-groupings declined, the exception being Merger Arbitrage which rose slightly (+0.1%); and
  
• Morningstar's Altvest Hedge Fund Index declined (-1.6%) and 11 out of 13 sub-groupings declined. Two specialist groupings had positive returns - health care (+0.4%) and technology (+0.3%), reflecting the relative sharemarket strength of those industry sectors.
  

Each of the hedge fund index providers listed above publish a range of sub-groupings. Each cuts the results in different ways; some with a strategy orientation, some with a geographic orientation and others with a sector orientation. Some providers show fund of fund results and others single and multi strategy results. Taking each of the sub-groupings published by the above 5 providers, and recognising that there will be elements of overlap, the following chart shows the results for August 2007.

The widespread declines in the hedge fund sub-groupings in August 2007 (56 declines out of 59 sub-groups) suggests that there is a "hidden factor" or "groupthink" at work that has caused many hedge funds to behave in a similar way, no matter what the strategy being employed. Amongst equity long/short funds, where you would expect there to be little or no correlation with events in the US sub-prime market, only 378 (30%) of the 1,263 funds in the Morningstar (Altvest) Survey showed a positive return.

Could it be that hedge funds have a greater exposure to credit spreads than expected? If so, this makes funds that are able to extract returns which are not influenced by this factor more valuable, as they are more likely to generate returns that are not correlated with hedge fund returns generally.

At the least, it suggests that it would be useful to have more detailed research of this observation, preferably at the fund rather than index sub-group level.

By Rick Steele

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