Hedge funds were down -3.43% in 2002, according to the Hedge Fund Index published by the Hennessee Hedge Fund Advisory Group. This is the first negative year the hedge fund industry has experienced since the Hennessee Group began monitoring ity in 1987.
Nonetheless, hedge funds still handily outperformed the broad US equity markets as the S&P 500 fell -22.19%, the Dow Jones Industrial Average dropped -16.76%, and the Nasdaq was down -31.52%. In addition, Lipper Mutual Funds were down -18.77% in 2002.
Hedge funds had another bad month in December, according to Hennessee, falling -0.58% over the month. This was still better than the S&P 500 Index, which lost -5.90%, the Dow Jones Industrial Average which fell -6.23% and the Nasdaq Index, which decreased
“With market volatility extremely high and the broad markets suffering 5%+losses, hedge funds proved their value added once again by posting a slight loss for December,” says Charles Gradante, Managing Principal of Hennessee Group LLC. “This downside risk management is further evidenced by the yearly figures for 2002. The average hedge fund beat the broader indices by 20%.”
December continued to cause problems for hedge fund managers as the Volatility Index (VIX) once again averaged above 30 for most of the month while market conviction and sentiment declined. Short Biased hedge fund managers profited as the markets took a negative turn, posting a +3.05% return for December.
Latin America managers posted a third straight positive month with a +2.90% return for the month, as the Brazilian and Argentine markets rallied 9% and 15% respectively, despite troubles in Venezuela.
The third best performing hedge fund managers for the month were Distressed managers with a +2.77% return as spreads seemed to stabilize and the default rate in high yield debt continued to trend lower.
“The performance of distressed and high yield hedge fund managers is positive for the overall equity and bond markets,” states Gradante. “Even so, the Hennessee Group is concerned with hedge funds that are using the credit default swap market for speculation and not for hedging. According to Hennessee sources, the level of this speculation is at an all-time high, increasing performance risk for these managers.”
Several political and economic factors affected the performance of Long/Short Equity managers in December. Market uncertainty, spurred by the announcement of a 6% unemployment figure and the weakest holiday shopping season in thirty years, was intensified by the possible increase in energy costs due to the turmoil in Venezuela and the looming prospect of war with Iraq. As a result Opportunistic managers fell by -3.53% and Growth managers fell by -2.64%. Additionally, after two strong, positive months, Healthcare/Biotech managers fell -2.67% as many high beta biotech names sold off with the rest of the market.
“In 2003, the best performing hedge fund managers will be those that effectively negotiate a market characterized by low conviction and high volatility,” concluded Gradante.