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February Hedge Fund Review

Another strong month for hedge funds.

Mallory Horejs, 03/29/2012

The Morningstar MSCI Composite Hedge Fund Index, an asset-weighted composite of nearly 1,000 hedge funds in the Morningstar database, increased 1.2% in February but significantly lagged the MSCI World NR Stock Index's 4.9% rise. Global equities continued to rally throughout the month, and risk aversion further declined. With the exception of short-biased strategies, all hedge fund categories posted gains for the month. For the second month in a row, equity-oriented hedge fund strategies led the way with the largest increases.

Emerging market equities again posted the largest gains as the Morningstar MSCI Emerging Markets Hedge Fund Index rose 3.5% against the MSCI Emerging Market NR Stock Index's 6.0% increase. European equity markets also delivered strong numbers, as both the European Central Bank's liquidity program and Greek bailout package buoyed market sentiment. The Morningstar MSCI Europe Hedge Fund Index rose 2.3% against the Morningstar MSCI Europe NR Stock Index's 6.3% increase.

The United States economy continued to show signs of improvement in February, as previous GDP estimates were revised upward and new claims for jobless benefits declined to their lowest level in four years. The Morningstar MSCI North America Hedge Fund Index climbed 1.7% but fell short of the S&P 500's 4.3% surge.

Equity-oriented strategies also benefited from falling correlations across stock sectors and geographies. The CBOE S&P 500 Implied Correlation Index, which reached record highs in December 2011, steadily declined to more-normalized levels throughout February. Fundamental stock-pickers generated profits in this less-correlated environment, and the Morningstar MSCI Security Selection Hedge Fund Index rose 2.8%.

Despite the month-end sell-off of precious metals, sustained upward trends in energy and equity contracts throughout the month enabled trend-following strategies to deliver gains. Energy contracts rallied as geopolitical concerns surrounding Iran's nuclear ambitions drove oil prices higher. The Morningstar MSCI Directional Trading Hedge Fund Index, which includes funds that speculate on price trends across various asset classes, rose 1.5%.

Relative-value strategies also fared well but posted more muted gains for the month. The Morningstar MSCI Relative Value and Morningstar MSCI Convertible Arbitrage Hedge Fund Indexes rose 1.0% and 0.7%, respectively. Merger arbitrage and corporate actions strategies in particular profited from the rebound in European deal flow. Merger activity in the region ground to a halt in the second half of 2011 amidst sovereign debt uncertainty and recessionary fears, but rising risk appetites sparked a flurry of new deals in January and February. The Morningstar MSCI Merger Arbitrage and Event-Driven Hedge Fund Indexes rose 0.7% and 1.9%, respectively.

Hedge funds in Morningstar's database leaked almost $1.5 billion in January, marking the fourth consecutive month of significant outflows. Most categories experienced redemptions, but global long/short equity and global macro funds were the hardest hit, leaking $873.6 million and $803.1 million, respectively. Funds in the event-driven category also struggled, as investors pulled out $374.8 million in January. Diversified arbitrage and systematic futures funds did manage to gather more assets, though, with the categories enjoying $787.7 million and $582.1 million in inflows for the month, respectively.

Hedge funds of funds in Morningstar's database also suffered from massive redemptions, totaling more than $1.7 billion in January. Single-manager, multistrategy hedge funds of funds fared much better, experiencing only $20 million in outflows.

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Mallory Horejs is an alternative investments analyst with Morningstar.
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