The Hennessee Hedge Fund Index advanced +1.28% in January while the S&P 500 declined 3.48%, the Dow Jones Industrial Average fell 3.03% and the NASDAQ Composite Index declined 4.95%.
Outside of Treasuries, the fixed income markets were in more disarray than equities. The Lehman Aggregate Bond Index declined 0.56%.
“While it was a reasonable month for long/short equity funds in February, 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,” says E. Lee Hennessee, managing principal, Hennessee Group.
The Hennessee Long/Short Equity Index advanced +0.93% in February. 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 markets decline.
While most long/short equity managers are finding a number of attractively priced opportunities, most recognize the markets poor liquidity will likely drive prices in the short term and potentially allow for purchases at lower levels.
“Its likely that AIGs write-off within its credit default swap portfolio will be followed by similar write-offs by many of the large banks. Banks may have another $200 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,” says Charles Gradante, managing principal, Hennessee Group.
The Hennessee Arbitrage/Event Driven Index advanced +0.34% in February. The Hennessee Distressed Index advanced +0.79% for the month. 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. The Hennessee Merger Arbitrage Index declined 0.56% for the month. 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.
The Hennessee Convertible Arbitrage Index declined 0.56% in February. Despite the markets 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 strategys poor performance in 2007.
“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,” adds Gradante.
The Hennessee Global/Macro Index advanced +2.55% in January. After struggling in January, international equities and international long/short equity funds outperformed their US counterparts in February. The Hennessee International Index returned +2.51%, while both the MSCI Europe and MSCI Asia-Pacific Index posted positive returns for the month as economic weakness in the US has yet to spread to other regions of the world.
The Hennessee Macro Index advanced +3.92% for the month, as almost every theme common among macro funds posted positive returns. Commodities 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.