03.20.2012
By Terry Flanagan

Hedge Funds Go Back To Basics

A return of market fundamentals is allowing hedge funds the ability to recover losses stemming from the huge trading volatility witnessed last year.

Hedge funds have posted their best start to a calendar year since 2000, according to recent data from Hedge Fund Research, with a positive performance recorded across all main strategies.

“It has been a strong start to the year for hedge funds,” said Mark Parsonson, executive director of UK-based fund of hedge funds manager Liongate Capital Management, which has $3bn under management.

“Last year, there was a lot of volatility in the summer months of 2011 and through October and November; it was an exceptionally difficult trading environment. The volatility was high, although not as high as 2008, but it was the length of the volatility that was dramatic. It was among the longest periods ever of sustained volatility.

“Correlation across assets was also at an all-time high. If you are a hedge fund, traditionally when markets have declined you have been able to make money in two ways. Firstly, the ability to go short, which most other market participants don’t have the ability to do, and secondly, the ability to pick stocks that were likely to go down more than long positions.

“What happened last year was there wasn’t that stock or asset dispersion in the markets. With the market being whip-sawed with no clear direction, hedge funds got caught up in the volatility, along with everyone else.

“But it has been a very good start for hedge funds in 2012; certainly if you look at the headline numbers its been the strongest start since 2000. Last year, where everybody was trading based on macro sentiment, tremendous valuation opportunities opened up in individual assets and stocks with favorable fundamentals.

“The LTRO [the Long Term Refinancing Operation, in which the European Central Bank has handed out over €1 trillion in cheap loans to lenders in the last three months] in Europe took a lot of the imminent risk off the table, providing a lot of liquidity and stabilizing the banking sector. With the perception of less macro risks, markets have shifted to focusing on fundamentals.

“Hedge funds have benefitted from this. Clearly the rally has helped, but dispersion has been the real driver. When markets focus on fundamentals, hedge funds have historically found the opportunities to out-perform. This has been their traditional bread-and-butter. For investors seeking returns, with absolute yields as low as they are and equity markets having rallied significantly, hedge funds represent an interesting opportunity.”

Chicago-based Hedge Fund Research, a provider of data and analysis to the alternative investment industry, says its non-investable HFRI Fund Weighted Composite Index rose 2.14% in February, with gains for the first two months of the year reaching nearly 5%. In the whole of 2011, the index declined by -5.26%.

“Hedge fund performance through early 2012 has benefitted from the improvement or total reversal of the trends, sentiment and volatility which contributed to the challenging environment in 2011,” said Kenneth J. Heinz, president of Hedge Fund Research.

“While equity market volatility may rise from early 2012 subdued levels, hedge funds are well positioned in the current environment to opportunistically adjust exposures and generate gains across multiple asset classes globally in 2012.”

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