Hedge fund managers are still reporting some fairly uninspiring figures to the specialist indexing houses. In a month (August) which held some fairly bright spots for equity markets, particularly in Asia, managers of equity long/short portfolios do not appear to have been able to capture the upturn, despite a bias on the long side.
The trend for outperformance by distressed securities and other event-driven strategies has continued. Eurekahedge figures for August indicate that distressed debt was up 1.48%, and 6.28% year to date, while event driven put on 0.93 in August and is 9.57% YTD.
Event driven strategies seek to exploit individual corporate events. The most common styles are merger arbitrage and distressed security investing. Merger arbitrage funds generally invest in both parties to a merger upon its announcement. In the case of stock transactions, they ‘short’ the acquirer and buy the company being acquired. The returns of merger arbitrage funds have historically been in the region of 10-15% per annum, and have little correlation with equity markets, although they are vulnerable to market crashes.
Distressed securities managers commonly buy the under-valued securities, or bank debt, of companies or financial distress or bankruptcy proceedings. Some managers play an active role in negotiating private deals and loans and participating in reorganisations. The returns of distressed debt funds vary, but are generally highest at times of economic recovery. Distressed securities strategies are generally characterised by a relatively high return and a significant correlation with major bond and/or stock indexes. Consequently, distressed securities strategies may be used as ‘return enhancers’ in portfolios. In 2003, distressed debt was up by 25% according to Eurekahedge.
The performance of these funds depends on their ability to assess the probability of success of the different restructuring options, which in turn allows them to identify the securities that may be interesting in the case of an arbitrage strategy and the eventual amount of the investment to be made.
About 60% of the 1,700 funds in the Van Global Hedge Fund Index reported a negative return in July. Overall the index was down 0.9% net of fees. To put this in perspective, hedge fund managers did better than the main equity markets. About 88% of the funds in the Van Global Hedge Fund Index beat the S&P 500 in July. However, the bounce back in August is not reflected in hedge fund portfolios generally.
Managers following a long/short equity strategy are continuing to struggle with the market conditions. These funds typically have a long bias and therefore at least a moderate correlation to the stock market. Eurekahedge’s Alex Mearns comments that for funds in August, there is a clear pattern of long/short managers failing to capture the upturn, while arbitrage funds were also marginally down for the month due to continued low volatility and small trading volumes.
The best performing fund in August tended to be focused on Korea, Taiwan or Hong Kong, with markets up 9.3%, 6% and 5% respectively. The surprise package was India where, despite only a marginal run up by the market, India-focused funds performed well, up 4.1%.