By Justin Dew
SPECIAL REPORTHEDGE FUNDS
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S&P on Hedge Funds' Hot Month
Hedge fund returns gained 0.98% during the month of July, as measured by the S&P Hedge Fund Index (S&P HFI). All three of the S&P HFI subindexes registered positive gains last month. Year-to-date through July, the S&P HFI is up 1.11%.
Three main factors drove hedge fund performance in July: China's revaluation of the yuan, rising corporate earnings, and a strong follow-through of bull market indications first recognized in May. The Chinese announcement of the slight revaluation had a sizable, albeit temporary, effect on the currency markets during July and was an indicator of further changes to come.
RESTRUCTURING FINALES. In the equity sector, investors had been expecting single-digit earnings growth and were pleasantly surprised at the continued double-digit gains. This elation manifested itself in the form of strong equity-market returns over the course of the month. Indications of a bull market continue to occur as exemplified by the current healthy economic growth, increasing earnings, and low inflation -- all in addition to a sector rotation often seen in the beginning stages of a bull market.
The S&P Event-Driven Index gained 1.51% in July as all three of its underlying strategies ended the month with positive returns. The Special Situations sector performed admirably as a number of post-bankruptcy restructurings -- having occurred over the past two years -- finally came to fruition. Positions falling into the classification of "Merger/acquisitions" were generally positive in July, as the merger environment continued to prosper and a number of subsidiary spin-offs were either announced or completed.
DONE DEALS. In the Distressed sector, managers profited strongly as spreads tightened toward March levels, and indications were that the contraction could continue. Positions in the automotive industry, hurt by the downgrade of General Motors (GM) and Ford (F) debt, were a profit leader as prices rebounded strongly off lows, in some cases causing profit taking.
Merger Arbitrage continued its strong run, as many deals closed over the course of the month with an unusually large number also announced. Spreads on these transactions have widened, and competitive bids have increased, resulting in additional opportunities for the sector as evidenced by the competitive bid for Unocal (UCL) by Chevron (CVX) in July.
The S&P Arbitrage Index gained 0.73% in July, led up for the second month in a row by the performance of Convertible Arbitrage, which had difficulties early in the year but has rebounded in recent months. Some managers in this sector have taken the first-quarter decline in convertible-bond prices as a buying opportunity. That turns out to be an insightful decision, as prices have risen steadily off their lows.
SEMICONDUCTORS REAP. In the Fixed Income Arbitrage sector, gains resulted from U.S. swap spread curve normalization (particularly on the short end), as well as profits on options relating to the shape of the U.S. Treasury curve (on the long end). Continued low levels of volatility in the equity market, as measured by the VIX, led to a difficult trading environment for most Equity Market Neutral managers in July.
The S&P Directional/Tactical Index gained 0.7% in July as global equity markets rose strongly during the month. For the most part, managers in the S&P Equity Long/Short Index registered strong performance, returning 2.08%. The S&P 500 gained 3.6% during July in the face of terrorist attacks in London and Fed tightening, leading some managers to have faith in the rising corporate profit numbers and generating a more bullish outlook for the near term.
Specifically, positions held in the financial and semiconductor sectors profited, as did positions in the energy sector as energy prices continued their ascent. Year-to-date through July, the S&P Equity Long/Short Index returned 3.15%, vs. 1.84% for the S&P 500.
BOMBING CONSEQUENCES. In the Managed Futures sector, performance was flat to down as China announced the yuan revaluation, causing temporary fluctuations throughout the currency market. Some Managed Futures models, which had been long bonds (short rates) for some time, experienced sizable losses in global fixed-income markets as interest rates rose during July.
Fixed income rates increased throughout much of the month on the heels of improving economic conditions in the U.S. Only the London bombings early in July had a dampening effect on this trend and only temporarily. (See sp-hedgefundindex.com for daily updates of returns, as well as finalized monthly values, methodology, index change announcements, and constituents.) Dew is senior hedge-fund specialist for Standard & Poor's