Hedge funds post strong first quarter
Energy, metals and mergers boosted results for these funds in March. But fixed-income funds lagged.
NEW YORK (CNNMoney.com) - Hedge funds posted a strong first quarter, thanks to the continued boom in energy and hefty gains in the metals markets.
The major hedge-fund indexes, which track aggregate returns for all strategies, showed gains ranging from 3.26 percent to 5.87 percent in the first quarter. By comparison, the S&P 500 returned 3.73 percent in the quarter. Increases in January and March offset the flattish results hedge funds saw in February.
Most strategies tracked by the major hedge-fund indexes posted gains in March, with managed-futures funds emerging as the clear winner. These funds gained 3.95 percent in March, according to the Standard & Poor's Hedge Fund Index, wiping out losses earlier in the year for a first-quarter return of 3.11.
"It's been a great first quarter," said Carrie McCabe, CEO of Financial Risk Management LLC, a "fund of funds," or fund that invests in hedge funds. "Really diversified funds of funds are up about 4 to 5 percent for the quarter. Non-U.S. investment strategies are doing well right now; Asia, including Japan, and Europe have done well."
Strength in metals, including gold and copper, accounted for the gains in these funds, and a continued boom in energy also helped. That momentum continues in the current quarter. Gold futures surged past $600 last week on fears of inflation, while silver hit a 23-year high Monday.
Managers who mostly play currencies had a tougher time, said Charles Davidson, senior hedge fund specialist at Standard & Poor's.
"Gold, copper and zinc have been moving strongly, but currencies have been more difficult for people," said Davidson. "The largest (managed futures funds) focus on currencies, and that's been more difficult."
Energy-focused funds continued their gains. The HedgeFund.net energy sector index posted a 3.80 percent gain for the month and was up 8.56 percent for the quarter.
Hedge funds, which are private investment pools open to institutions and wealthy individuals, employ a wide variety of investment strategies, ranging from garden-variety stock investing to betting on the outcome of merger transactions to investing in emerging markets.
Tracking hedge-fund performance is difficult, since these funds are private and are not required to share their returns with anyone but investors. Also, not all hedge-fund indexes track the same funds, and often rely on data reported by the fund managers themselves.
Energy boom lifts equity funds, too
The strong performance in energy boosted the coffers of long/short equity funds that invest in the stocks of energy companies, said Ben Bornstein, founder and portfolio manager of the Prospero Capital hedge funds.
Long/short equity managers posted gains of 2.32 percent in March and 6.35 percent during the first quarter, according to Chicago-based, hedge-fund tracker Hedge Fund Research. These funds hedge their investments in stocks by "shorting" the stocks of companies they think are overvalued, essentially betting on a drop in share prices.
"It was easier to find the good valuations and bad valuations," Bornstein said. "That was particularly true if a fund managed to focus on the right sectors, particularly energy."
Bornstein added that the current interest-rate environment is giving a boost to long/short equity managers on the short side. That's because hedge-fund managers earn "short rebates." Proceeds from short sales are typically re-invested in a Treasury bill account that is held with a fund's broker as collateral. Much of the interest this account generates is returned to the manager.
"That short balance is earning 4.25 percent, so right off the bat (my short portfolio) starts the year with a 4.25 percent gain," he said.
Davidson of Standard & Poor's said strong performance in small caps, as well as in particular sectors including energy, mining and telecommunications, also drove the performance of long/short equity funds.
Merger market still going strong
March's merger madness drove the strong performance of event-driven funds, which anticipate and seek to profit from corporate events such as mergers or restructurings. Event-driven funds gained 1.4 percent in March and 4.68 percent for the quarter, according to Standard & Poor's.
Hedge funds betting on mergers seek to profit from the "spread" between the current market price of a company being acquired and the price once a deal has gone through. Managers usually buy the stock of the company being acquired while betting against the acquirer.
Peter Schoenfeld, founder of the $1.2 billion event-driven firm P. Schoenfeld Asset Management, said several market factors have converged to create an ideal environment for mergers.
"The regulatory environment is benign, and balance sheets here and in Europe, apart from auto and airlines, have never been stronger," said Schoenfeld. He added that while the stock market has traditionally rewarded companies for returning cash in dividends and buybacks, Wall Street has grown impatient with that strategy as cash balances have grown ever larger.
"That strategy doesn't make sense if you want to retain a high multiple," he said. "The stocks of acquiring companies have behaved well in the marketplace, which is an endorsement for the process."
Shareholder-activist funds, which agitate for change at a target company in hopes of increasing the company's share price, are continuing to offer potential for returns both in the U.S. and abroad, he added.
"Europe has its own style and has been an exciting arena," he said. "We have seen an unusual number of hostile bids in Europe that have significant geopolitical implications and whose outcomes will determine the nature of the playing field for the rest of the decade."
FRM's McCabe said "relative value," or arbitrage, strategies have also performed well. Arbitrage is the simultaneous purchase and sale of similar securities to exploit differences in pricing; merger arbitrage and convertible arbitrage are two well-known relative value strategies.
Convertible arbitrage hedge funds are up 1.63 percent for March and 5 percent for the quarter. But their coffers are significantly less than they were last year, owing to a very tough 2005 that caused a handful of very large convertible arbitrage funds to shut their doors.
Fixed-income funds didn't share the strong gains its hedge-fund brethren experienced. The Hedge Fund Research diversified fixed income index posted a loss of 1.17 percent for March and is up only 0.85 percent for the quarter.
Davidson of Standard & Poor's said some fixed-income managers bet that the so-called yield curve would steepen, meaning they thought the gap between interest rates between short- and long-term bonds would increase.
Long-term bonds typically command higher interest rates than short-term bonds, but the two flip-flopped earlier this year, creating what's called an "inverted yield curve." Long-term bond yields have been rising, but not as fast as some managers had hoped, and they are still hovering near 10-year rates.
"I think a lot of people thought the curve would steepen, and it didn't happen in the time they anticipated," said Davidson.
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