June Hedge Fund Review

The Morningstar MSCI Composite Hedge Fund Index, an asset-weighted composite of nearly 1,000 hedge funds in the Morningstar Hedge Fund database, fell 0.9% in June, while the MSCI World Stock Index soared 5.1%. Hedge fund strategies came up short in June despite strong overall equity market performance. Trend-following funds were hit especially hard due to several midmonth price-trend reversals across asset classes.

The Morningstar MSCI Systematic Trading Hedge Fund Index, which includes funds that trade liquid global futures, options, and foreign-exchange contracts largely according to momentum strategies, sank 3.0% in June, its largest decline in eight months. Longer-term price-trend trading proved difficult due to sharp midmonth and month-end reversals across global equity markets. Shifting investor sentiment also led to sharp reversals across currency markets, with the euro appreciating notably against the U.S. dollar at month-end following positive developments at the European Union Summit. The Morningstar MSCI Currencies Hedge Fund Index managed to stay afloat though, inching up 0.1% for the month.

International equity-oriented hedge fund strategies fared much better in June but significantly lagged the unhedged stock markets. The MSCI Europe Stock Index surged 7.9% after pro-austerity parties won Greek elections and European leaders announced the creation of a single banking supervisory body to address the region's debt crisis. The Morningstar MSCI Europe Hedge Fund Index, by comparison, rose only 0.4%. The Morningstar MSCI Emerging Markets Hedge Fund Index also stalled, climbing only 0.2% against the Morningstar MSCI Emerging Markets Stock Market Index's 3.9% jump.

Hedge funds investing in North American equities also largely underperformed the broad stock markets—the Morningstar MSCI North America Hedge Fund Index rose only 0.6% while the S&P 500 Index jumped 4.1% after the Fed announced it would continue Operation Twist until the end of the year. Smaller-capitalization strategies also lagged, with the Morningstar MSCI Small Cap Hedge Fund Index increasing only 1.1% against the Russell 2000 Stock Index's 5.0% ascent. Short-selling equity strategies posted the worst performance in June. The Morningstar MSCI Short Bias Hedge Fund Index was down 4.3% for the month and 9.6% for the year through June, more than any other Morningstar MSCI hedge fund index.

Fixed income performance was mixed in June as investors moved to riskier asset classes. The Barclays US Aggregate Bond Index fell flat for the month while the Barclays Global High Yield Index rose 2.8%. Despite a rally in high yield and leverage loans, the Morningstar MSCI Specialist Credit and Morningstar MSCI Long-Short Credit Hedge Fund Indexes posted small declines of 0.2% and 0.3%, respectively. The Morningstar MSCI Fixed Income Arbitrage Hedge Fund Index rose a slight 0.8%.

Single-manager funds in Morningstar's Hedge Fund database netted $1.8 billion in May, marking the fourth consecutive month of inflows. Credit strategies were in high demand and funds in the long/short debt and debt arbitrage categories received the most inflows of $385 million and $367 million, respectively. Multistrategy hedge funds also fared well, netting inflows of $363 million in May, while fund of funds overall leaked roughly $658 million. Morningstar's Europe long/short equity hedge fund category experienced the largest net redemptions of all single-manager categories, bleeding $169 million.