Hennessee Group LLC, a consultant and adviser to direct investors in hedge funds, has announced that the Hennessee Hedge Fund Index advanced +1.85% in August (+17.30% YTD), while the S&P 500 increased +3.36% (+12.99% YTD), the Dow Jones Industrial Average increased +3.54% (+8.20% YTD), and the NASDAQ Composite Index advanced +1.54% (+27.40% YTD). The Barclays Aggregate Bond Index advanced +1.04% (+4.62% YTD).
There was good economic news released in August, specifically housing and manufacturing data. However, our expectations for future growth and a V-shaped recovery are tempered. Government spending continues to drive demand, while the private sector has been largely absent. This dynamic is not sustainable, says Charles Gradante, co-founder of Hennessee Group. In addition, equity markets are no longer undervalued. The P/E ratio for the S&P 500 Index has gone from a March low of 10x to over 18x during the month of August. With September being one of the worst months historically, we are cautious of a pull back in the markets.
Hedge funds continued to lag the surging equity markets, as we would expect given their short portfolios and hedges, says Lee Hennessee, managing principal of Hennessee Group. Managers have opened up their exposures to benefit from the market rally. However, given the uncertainty around the economy, most managers are looking to generate gains due to stock selection, rather than beta exposure as there is potential for a correction.
The Hennessee Long/Short Equity Index gained +1.88% in August (+15.27% YTD). The U.S. equity markets continued their upward momentum in August boosted by positive economic data, particularly in the U.S. housing market and manufacturing sector. Financials were the primary driver of the equity markets, up a strong +12.9% in August. Financials gained support during the month on news several hedge fund managers were beginning to build significant equity positions in the financial sector, particularly Citigroup, which jumped +57% during the month. Many managers are also focusing on franchise-type businesses that have strong free cash flow, solid balance sheets, pricing power and the ability to increase market share. Going forward, managers will remain cautious with their exposures across sectors and rely largely on individual security selection as it is widely believed the market has gotten ahead of itself in recent months and is due for a correction.
The Hennessee Arbitrage/Event Driven Index gained +2.10% in August (+19.89% YTD). Positive contributions were wide spread with credit-related and convertible arbitrage strategies performing strong and merger arbitrage generating consistent, modest gains. Credit markets continued their strong rally with high grade returning +2.2%, its fifth straight positive month, and high yield returning +2.0%, its sixth straight positive month. The spread on the Merrill Lynch High Yield Index tightened further from 922 basis points to 912 basis points during the month, hitting a low of 857 basis points during the month. The Hennessee Distressed Index advanced +2.58% in August (+24.40% YTD). Distressed positions continued to benefit from the rally in credit. Managers remain optimistic on the opportunity set for the strategy and expect continued defaults. They report that the maturity schedule of bonds in the U.S. will require an acceleration of refinancing activity starting in 2011 with the credit markets needing to absorb $1 trillion in high yield refinancing over the next five years. The Hennessee Convertible Arbitrage Index advanced +2.96% (+34.53% YTD). Spreads, interest rates and buying in the secondary market made positive contributions. Redemptions remained high in August, with buybacks and tender offers accounting for almost 75% of the redemption volume. Managers also report that competition among prime brokers is increasing, and funds are seeing improvements in financing terms.
The Hennessee Merger Arbitrage Index advanced +1.18% in August (+6.20% YTD). Positive performance was largely from pharmaceutical risk arbitrage deals, which benefited from modest spread tightening. Managers state that spreads should continue to tighten as liquidity continues to increase. However, greater liquidity should also lead to a pick up in activity.
The Hennessee Global/Macro Index advanced +1.87% in August (+18.19% YTD). Global equities rallied as the MSCI EAFE Index advanced +5.16% (+21.14% YTD), driven largely by European markets. There are now clear signs that the global financial system has stabilized and a recovery is underway. The concern now becomes the extent to which it is priced into equity markets and what kind of recovery will unfold. The Hennessee International Index increased +1.83% (+14.51% YTD). Emerging markets displayed weakness, especially China, which officially entered a bear market as markets declined more than -20% in August. Many are concerned about the quality and sustainability of the Chinese stimulus program. Managers are expecting considerable macro uncertainty with markets likely to experience volatility. The Hennessee Macro Index advanced +0.83% in August (+9.06% YTD).
The reflation trade (long commodities against short Treasuries) is still widely held among macro managers. Managers continued to generate gains in metal positions as industrial metals, silver and zinc performed well and more than offset losses from increases in Treasuries. The 2-year Treasury yield dropped from 1.13% to 0.98%, and the 10-year Treasury yield fell from 3.50% to 3.40%. At the same time, the 30-year Treasury yield decreased from 4.31% to 4.18%.
D.C.