Reportedly strong equity markets contributed to positive performance of hedge funds in May, as the Hennessee Hedge Fund Index climbed +1.30% (-0.27% YTD).
The broad market indices were also positive for the month as the S&P 500 increased +3.18% (-0.96% YTD), the Dow Jones Industrial Average rose +2.70% (-2.93% YTD), and the NASDAQ Composite Index improved +7.63% (-4.93% YTD).
“The flat yield curve, low volatility (VIX), and tight equity trading range throughout 2005 continues to hurt hedge fund performance,” said Charles Gradante, managing principal of Hennessee Group LLC. “Many managers believe the equity markets are in the process of breaking out, but manager concerns about systemic risk in the credit markets continue to overshadow the positive views developing in the equity market.”
The Hennessee Long/Short Equity Index increased +2.04% (-1.00% YTD) in May. Managers were able to take advantage of the broad market rally, while limiting their losses on the short side.
The main catalyst sparking hedge fund returns was the lower than expected inflation number. Furthermore, managers believe the Federal Reserve’s comments indicating a possible end to interest rate tightening will help stocks to rally further and, as a result, hedge funds have increased their net market exposure.
“Equity managers had their best month for the year as stocks moved on fundamentals rather than technicals and indications of an economic ‘soft landing,'” stated Gradante.
The Hennessee Arbitrage/Event Driven Index was down in May, returning -0.03% (-0.99% YTD), as positive returns in merger arbitrage and credit related strategies were offset by losses in convertible arbitrage. Distressed managers were aided by a firming of the credit market and narrowing credit spreads after a sharp sell off in March and April. However, the convertible arbitrage market was hampered by the continued selling of convertible bonds, further compounding illiquidity, and the decline in volatility. Managers continue to search for the bottom.
“Convertible arbitrage managers are having their worst year since 1994. The decline in convertible bond prices continues due to forced sellers and credit risk fears,” commented Gradante. “Many managers reported that buying opportunities are developing and expect a turnaround in the second half.”
The Hennessee Global/Macro Index rallied +1.21% (+2.26% YTD) in May. Investors increased their risk appetite in May as the belief that the global marketplace would rally if indications of the cessation of interest rate tightening proved to be true. Net long equity exposure offset losses due to the flattening of the yield curve, the rally in the dollar, and the sell-off in gold. Finally, international equities rallied with the U.S. markets.