Risk appetite grew in the U.S., but global hedge fund returns were mixed.
A growing risk appetite in the United States pushed small cap equities and distressed securities higher in May, and hedge funds investing in these asset classes delivered the month’s strongest performance. However, global markets were mixed.
The Morningstar MSCI Composite Hedge Fund Index, an asset-weighted composite of nearly 1,000 hedge funds in the Morningstar Hedge Fund database, fell 0.2% in May but remains up 4.9% for the year to date. Over the trailing 12 months, the index rose 8.6%.
U.S. equities rallied throughout the month in response to encouraging economic data, including rising consumer confidence and home prices. Small caps led the way, with the Morningstar MSCI Small Cap and Morningstar MSCI Small & Mid Cap Hedge Fund Indexes climbing 2.9% and 3.1%, respectively. Both indexes, however, trailed the Russell 2000 TR Index’s 4.0% gain.
Overall global equity market performance proved lackluster in May, though, and the MSCI World NR Index remained flat for the month. Japanese equities swung dramatically, with the Nikkei 225 Index rising 11.3% by mid-month on euphoria over the Bank of Japan’s announced massive monetary stimulus plan designed to drive inflation up to 2%. However, the rally ultimately collapsed in response to weak Chinese manufacturing data, including a 7% one-day drop on May 23, which left the index down 0.7% for May. Hedge funds investing in this region provided relative downside protection though, as the Morningstar MSCI Asia Pacific Hedge Fund Index rose 1.32%. Emerging market hedge funds also sheltered investors in May. The Morningstar MSCI Emerging Markets Hedge Fund Index inched up 0.6%, while the MSCI Emerging Market Stock Market Index sank 2.6%.
Fixed income markets also declined broadly in May on discussions by the Federal Reserve that it might taper its quantitative easing program. These concerns drove down the Barclays US Aggregate Bond TR Index 1.8%. While global markets reacted negatively to rising U.S. interest rates, fixed income hedge fund managers were able to keep the Morningstar MSCI Fixed Income Hedge Fund Index unchanged in May, and the Morningstar MSCI Specialist Credit Index managed to eke out an increase of 0.1%. The environment proved healthier for fixed income arbitrage strategies, as the Morningstar MSCI Fixed Income Arbitrage Hedge Fund Index turned in a positive 0.5%. Hedge funds investing in riskier assets like distressed securities fared best though, as risk appetites continued to rise. The Morningstar MSCI Distressed Securities Hedge Fund Index rose 2.6% in May.
Challenging conditions continued for systematic trading and directional trading strategies in May, as the Morningstar MSCI Directional Trading Hedge Fund Index fell 1.3% and the Morningstar MSCI Systematic Trading Hedge Fund Index dropped 2.3%. Interest rates were the worst asset class for momentum strategies, as most bond markets experienced frequent reversals. Within the commodity space, coffee and sugar showed the strongest trends, while wheat and crude oil showed the choppiest trading.
In April 2013, single-manager funds in Morningstar’s Hedge Fund Database gained $1.3 billion in inflows. Merger arbitrage hedge funds gathered the most assets, netting $1.6 billion, followed by multistrategy hedge funds, which gained $483 million during the month. Hedge funds in the global macro and distressed securities categories saw the greatest outflows in April, losing $434 million and $171 million, respectively. Over the trailing 12 months, investors have pulled $6.0 billion in aggregate from hedge funds in the Morningstar database. Roughly $5.0 billion were withdrawn from systematic futures hedge funds alone over this period, while global macro hedge funds gained $3.0 billion.