Hennessee Group says the hedge funds it tracks underperformed the broad equity markets in July. The Hennessee Hedge Fund Index decreased -0.11% (+5.28% YTD). The broad equity market indices were mixed for the month, as the S&P 500 DRI advanced +0.62% (+3.35% YTD), the Dow Jones Industrial Average rose +0.32% (+4.37% YTD), and the NASDAQ Composite Index declined -3.71% (-5.16% YTD). The bond markets rallied in July, as represented by the Lehman Brothers Intermediate Government Corporate Bond Index, which increased +1.12% (+0.94% YTD).
“Hedge funds underperformed the broad equity markets for the second month in a row,” says E. Lee Hennessee, Managing Principal of Hennessee Group LLC. “Hedge fund portfolios that did not have asset allocations to distressed (+8.35% YTD), merger arbitrage (+8.31% YTD), or convertible arbitrage (+7.33% YTD), likely underperformed the Hennessee Hedge Fund Index for July and the year.”
The Hennessee Long/Short Equity Index decreased -0.20% in July (+4.80% YTD). While the equity markets sold off during the first half of the month due to economic uncertainty and geopolitical issues in the Middle East, most markets were able to rally back and finish the month up modestly. Second quarter earnings reports generally met expectations, although a number of companies revised guidance lower for the second half of the year.
“Most equity hedge fund managers believe the ‘easy money’ is over as lower forward earnings guidance in July led to a flight to quality from the NASDAQ and Russell 2000 (-3.71% in July) to defensive sectors and bigger cap stocks,” says Charles Gradante, Managing Principal of Hennessee Group LLC. “On a positive note, managers report that the market is focusing on short term geopolitical events and ignoring long term fundamentals. These managers have added to positions believing that they will pay off over time.”
The Hennessee Arbitrage/Event Driven Index was up in July, returning +0.42% (+7.34% YTD). Merger arbitrage had a good month, returning +0.70% (+8.31% YTD). The acquisition of HCA by a consortium of private equity investors was further evidence of the growing influence of private equity funds. Should the deal be completed, it will represent the largest LBO ever, exceeding the amount of KKR’s takeover of RJR Nabisco. Convertible arbitrage funds posted another positive month, up +0.45% (+7.33% YTD). Valuations within the secondary convertible market generally appreciated as implied volatility increased and new money was invested in the strategy. Within credit-oriented strategies, distressed posted gains of +0.21% (+8.35% YTD). While credit spreads again widened slightly, they have been remarkably resilient in light of the volatility in the equity markets, as spreads have only widened by 50 basis points over the past three months.
The Hennessee Global/Macro Index decreased -0.69% in July (+3.00% YTD). Contrary to concerns about inflation, the U.S. bond markets strengthened in July, as the yield on the 10 Year Treasury Note declined from 5.15% to 5.00%. Both the eurozone and Japan raised interest rates by 25 basis points during the month, creating volatility in the currency markets, although the U.S. dollar ended the month little changed. Equity markets held up relatively well in the face of the rate hikes, as European markets were up and Japan posted only minor losses. Energy markets were also strong as natural gas prices recovered 50% from their intra-month lows and oil ended the month at $75 per barrel.
“Macro managers are still having a difficult year as macro economic themes of higher 10 Year Treasury yields, stronger emerging markets, and higher gold prices did not pan out,” says Gradante. “The volatility in natural gas from $6.50 to $5.60 before spiking up to $8.25 caused a managed futures fund, MotherRock, to liquidate.”