Hedge Fund Returns Plunge Amid Equities Bloodbath
Monday, September 12, 2011

Early reports of an August 'bloodbath' for hedge funds as the world's equity markets bombed appear to have been confirmed by research showing that hedge funds suffered their worst monthly returns since May 2010.

According to Hedge Fund Research, hedge funds, as well as broader financial markets, were negatively impacted by the combination of continued and accelerating concerns relating to the European sovereign debt crisis, the debate surrounding the US debt ceiling, the downgrade of US Treasury securities, and evidence of general economic and employment weakness in the US.

The HFRI Fund Weighted Composite Index declining by -2.3% last month, data released by HFR on September 8 shows.

The weakest areas of hedge fund strategy performance in August included Equity Hedge and Event Driven strategies, which declined by -4.1 and -3.7%, respectively. Both strategies posted their 4th consecutive month of negative returns, the longest drawdown since the Financial Crisis of 2008, and were significantly impacted by declines across major global equity markets ranging from -4 to -15%.

The contrasting fortunes of funds maintaining a short bias were demonstrated in HFR's report, with these funds posting gains of +6.9% in August, the 4th consecutive month of gains for such funds.

“The volatile environment for hedge funds in August exhibited certain similarities to the Financial Crisis of 2008, but exposed key differences, with significant implications for both investors and hedge fund managers,” stated Kenneth J. Heinz, President of HFR Inc. “Similar to 2008, Equity and Credit sensitive strategies were the weakest area of performance while Macro Systematic funds were tactically positioned for the volatile environment. In contrast, however, financial markets maintained liquidity in August, with risk dynamics concentrated in developed market sovereign credit and employment, as opposed to 2008, when the overhang of excessive levels of private consumer and mortgage debt were the primary catalysts.”

Bearish sentiment on US equities looks set to continue, according to the latest BarclayHedge and TrimTabs Investment Research fund manager survey, announced on September 6. Bearish sentiment on the S&P 500 among hedge fund managers soared to 42% in August, the largest reading in a year, from 27% in July. Bullish sentiment sank to 27%, the smallest reading in four months, from 43%.

“This reversal to extremely bearish from markedly bullish is striking,” says Sol Waksman, founder and President of BarclayHedge. “Especially sour moods probably owe in part to the recent crash in the S&P 500, which plunged 16.8% between July 22 and August 8. Additionally, on August 9, the Fed announced it feels downside risks to the economic outlook have increased so much that it plans to keep the policy rate at exceptionally low levels until the middle of 2013.”

Hedge fund managers have turned modestly bearish on the US dollar, the TrimTabs/BarclayHedge survey reveals. Bearish sentiment on the US Dollar Index increased to 34% in August from 30% in July, while bullish sentiment decreased to 24% from 33%. Meanwhile, managers remain downbeat on long-dated Treasuries. Bearish sentiment on the 10-year note stands at 32%, while bullish sentiment sits at 15%.

“Hedge fund managers have been net bearish on the long end all year even though the 10-year yield plunged to a record low of 2.07% in August from 3.75% in February,” notes Leon Mirochnik, CFA and Associate Portfolio Manager at TrimTabs. “Flows have also proven resilient. Demand at recent Treasury auctions was robust, Treasury mutual funds and ETFs continue to pull in cash, and fixed income hedge funds boast one of the heaviest year-to-date inflows of all hedge fund strategies.”

More than half of the respondents to the survey (56%) believe that the US economy is already in recession or will slip into recession soon. Only 3% feel economic growth is poised to accelerate.

“This pessimistic view squares with recent downward GDP revisions from the Fed, the IMF, and many Street forecasters,” notes Mirochnik. “Additionally, hedge fund managers tell us they are most upbeat on defensive sectors (Utilities and Consumer Staples) and least upbeat on risk sectors (Consumer Discretionary and Industrials). Consumer Discretionary is up 20.7% in the past year, the second-best performance of all sectors, but hedge fund managers feel strongly that moving away from risk is now the right way to go.”