1st Half 2009 Hedge Fund Returns

Courtesy of Credit Suisse / Tremont Hedge Index (http://www.hedgeindex.com/)

As we are now a little past half way through the year, I believe it is important to take a quick glimpse at how the markets are doing. Overall, the S&P 500 is up ~1.7%, the DJIA is down ~3%, and the NASDAQ is up ~14%. Mixed results, overall, but it is a welcomed trend given the destruction that occurred last year. Markets have also been buoyed over the past few days due to the much anticipated Goldman Sachs and Intel results - both of which came in above expectations earlier this week.

While the overall markets have remained flat (albeit, with significant volatility), hedge fund strategy returns have been extremely mixed. As I had predicted earlier this year, convertible arbitrage would come back strongly after the debt market was flooded with primary market issuance earlier this year. Convertible arbitrage is up an astounding 24% YTD, as credit markets continued to heal, while opportunities for shorting equities were abundant in the earlier part of this year. Given the massive rallies in all equities since the March lows, I am not surprised that dedicated short funds were down an average of 10% as well. What is an aberration, however, is the fact that equity market neutral funds are down an astounding 14% YTD.

Looking forward in the mid-term (+1 year), I do see three strategies doing well. First off, Global Macro should continue to do well, as there is still significant volatility in essentially all asset classes, and there will continue to be as long as there is the perception of risk in the markets and as long as world-wide governments, central banks, and various regulatory agencies continues to interfere in natural market mechanisms. One simply has to look at what has gone on in base metals, precious metals, energy commodities, equities, distressed debt, real estate, currencies, interest rates, etc. This playing field is a bonanza for Global Macro managers as they have access to essentially every asset class that is displaying huge, albeit, declining volatility.

Secondly, I expect Long / Short Equity managers to do well in this environment, because I do expect the VIX to be quite active in the near future, albeit in a trading range of 20 - 40 (it is currently at 26). Note that I view the VIX as the market's perception of current risk, and not future risk. With every market participant's heightened sense of risk and this economic crisis continuing, we are definitely not going back to below 20 on the VIX anytime in the near future. With Long / Short managers finally starting to catch their bearings after last years market rout, directional short-term trading and stock picking will be the main source of returns in the near future. Assuming most Long / Short managers have the wherewithal to stomach volatility and take advantage of short-term market swings, I do see this strategy performing as it has always been marketed to perform.

Finally, Event-Driven / Distressed Debt funds will also benefit in the coming years. Although M&A deal volumes and values are hitting all-time lows, it is only a matter of time before this market turns the corner and deals starts hitting the tape again. Risk-Arbitrage will be back when the deal market and hedge funds stabilize. Note that this is also dependent on the securities lending market and prime brokerage financing stabilizing as well. A separate, yet related strategy is the Distressed Debt strategy, and I strongly believe that we will see that come back as corporate bankruptcies (14,319 in the 1st quarter of 2009 - a number we have not seen since www.abi.org began recording in 1994) and restructurings continue to proliferate. We have already seen major funds flow into the sector, along with new restructuring funds being opened up. This type of activity will only increase, and therefore I do see numerous opportunities in this sector. However, these workouts will take time, and therefore returns will take longer to achieve.