Growth-stock troubles trip up hedge funds in March.
In a month characterized by diverging performance between growth and value stocks, hedge funds found themselves on the wrong side of the tracks. The Morningstar MSCI Composite AW Index, an asset-weighted composite of nearly 1,000 hedge funds in the Morningstar Hedge Fund database, fell 0.4% in March, while the Russell 2000 declined 0.7% and the S&P 500 rose 0.8%. Growth-tilted portfolios based on the same indexes, such as the iShares Russell 2000 Growth IWO and the iShares S&P 500 Growth IVW, plummeted 2.5% and 0.7%, respectively.
The Morningstar MSCI North America Hedge Fund Index, which represents primarily U.S. long-short equity strategies, declined 0.3% in March. The Morningstar MSCI Small Cap Hedge Fund Index, which represents primarily small-cap long-short equity strategies, increased a modest 0.2%. Equity-focused hedge funds, including long-short, security selection, and some global macro strategies, make up more than 50% of the Morningstar MSCI Composite AW Index and have an outsized impact on hedge fund performance. Over the five years ended March 2014, the Morningstar MSCI Composite AW Index's correlation to the S&P 500 is a significant 0.74.
Managed-futures hedge fund strategies were also negatively affected in March, as divergent markets disrupted directional trends. The Morningstar MSCI Directional Trading Hedge Fund Index, which includes both discretionary and systematic futures-based strategies, fell 1.4%, and the Morningstar MSCI Systematic Trading Hedge Fund Index sank 1.9%. For the 12 months ended March 2014, the Morningstar MSCI Directional Trading Hedge Fund Index decreased 0.1%, and the Morningstar MSCI Systematic Trading Hedge Fund Index declined 4.3% as hedge funds struggled with frequent reversals of investor sentiment in 2013.
Short-bias hedge funds were a bright spot, benefiting for the second-straight month from the sell-off in richly valued stocks, especially in the biotechnology and social-media sectors. The Morningstar MSCI Short Bias All Size Hedge Fund Index increased 0.8%, the second-largest increase of any Morningstar MSCI hedge fund index in March. This showing comes on the heels of a 4.4% gain in February. However, the Morningstar MSCI Short Bias All Size Hedge Fund Index has predictably struggled over the trailing 12-month period, declining 8.7% as markets rallied indiscriminately in 2013.
March returns for the Morningstar MSCI Hedge Fund Indexes are based on funds that reported as of April 22, 2014. Hedge fund investors, managers, consultants, and advisors can gain access to additional information through Morningstar DirectSM, the company's global research platform for institutions.