Hedge Funds Have Worst Quarter in Almost Four Years

Hedge funds experienced their worst quarter in almost four years, according to hedge fund index data compiled by Morningstar. The Morningstar 1000 Hedge Fund Index lost 1.51% in the first quarter of 2008. The index's rebound in February of 2.43% proved insufficient to cover the losses incurred in January (-2.38%) and March (-1.50%).

Lack of liquidity and economic uncertainty negatively impacted almost all hedge funds. The liquidity crisis that started in the summer of 2007 spilled over into 2008, punishing the markets and hedge funds' portfolios.

Among Morningstar's 17 hedge fund category indexes, equity-focused hedge funds bore the brunt of the economic damage, especially the emerging-markets and U.S. small-company hedge fund indexes, which tend to be more volatile than other equities. These indexes lost 8.58% and 8.70%, respectively, over the quarter, the worst of all 17 Morningstar Hedge Fund Indexes (see table below).

U.S. equity and developed Asia hedge fund indexes also chalked up large quarterly losses of 4.43% and 4.16%, respectively. These indexes lost half that of the S&P 500 and MSCI AC Asia Indexes, as hedge funds collectively lived up to their name and limited their downsides. The Europe equity hedge fund index even managed a small gain for the quarter of 0.53%, while the MSCI Europe Index lost 9.18%.

Trend-following hedge funds emerged as the clear winners, gaining 9.77% in the first quarter. These funds' outsized returns can be attributed to the runup in commodities such as energy, metals, and agriculture, as uncertainty led investors to pour assets into this sector. Non-trend macroeconomic funds also ended positively, up 2.04% for the quarter.

Equity arbitrage funds benefited from volatility in the market. The Morningstar Equity Arbitrage Hedge Fund Index returned 2.78% in the first quarter. Increased volatility was not enough to keep convertible arbitrage funds afloat, however. The Morningstar Convertible Arbitrage Hedge Fund Index lost 1.89% in the first quarter of 2008.

Debt arbitrage funds also suffered as spreads continued to widen across the credit spectrum. The Morningstar Debt Arbitrage Hedge Fund Index lost 3.12% in the first quarter of 2008. Rate cuts in the U.S. and the U.K. did little to improve the returns of global debt funds. The Morningstar Global Debt Hedge Fund Index barely squeezed out a 0.11% gain, significantly underperforming the Lehman Bond Global Aggregate.

Distressed securities hedge funds experienced another bad quarter, losing 3.14%. Corporate actions funds also performed poorly. The Morningstar Corporate Actions Hedge Fund Index lost 2.86%. Corporate events such as mergers and capital restructurings require market liquidity, which has been lacking since the middle of 2007.

The Morningstar Hedge Fund of Fund and Multi-Strategy Indexes fared about as well as the general index, losing 1.52% and 1.54%, respectively.

Morningstar has approximately 8,700 hedge funds and funds of hedge funds in its database. We recently launched the Morningstar 1000 Hedge Fund Index, a global, broadly representative benchmark for hedge fund performance. The index is composed of the top 90% of eligible assets in Morningstar's hedge fund database. For the purposes of the index, Morningstar counts funds with shared portfolios as a single hedge fund; funds of hedge funds are excluded from consideration. The index is updated daily for the previous month-end, rebalanced monthly, and reconstituted semiannually. In addition, Morningstar has 17 category indexes based on Morningstar's strategy-specific classification system for hedge funds.

For more hedge fund performance data, visit Morningstar's Hedge Fund Center.

Morningstar Hedge Fund Index and Category Performance ( % )
	Jan-08	Feb-08	Mar-08	1Q 08
Morningstar 1000 HF PR USD	-2.38	2.43	-1.50	-1.51
Morningstar Convertible Arbitrage HF PR USD	0.24	0.08	-2.21	-1.89
Morningstar Corporate Actions HF PR USD	-2.77	2.81	-2.82	-2.86
Morningstar Debt Arbitrage HF PR USD	-0.70	0.53	-2.95	-3.12
Morningstar Developed Asia Equity HF PR USD	-3.35	0.87	-1.70	-4.16
Morningstar Distressed Securities HF PR USD	-2.05	0.14	-1.25	-3.14
Morningstar Emerging Markets Equity HF PR USD	-7.62	3.61	-4.49	-8.58
Morningstar Equity Arbitrage HF PR USD	-0.14	2.88	0.04	2.78
Morningstar Europe Equity HF PR USD	-2.17	2.63	0.12	0.53
Morningstar Global Debt HF PR USD	-0.60	0.11	0.60	0.11
Morningstar Global Equity HF PR USD	-4.97	3.69	-2.26	-3.69
Morningstar Global Non Trend HF PR USD	0.77	2.24	-0.96	2.04
Morningstar Global Trend HF PR USD	2.59	8.18	-1.09	9.77
Morningstar Multistrategy HF PR USD	-2.29	2.29	-1.49	-1.54
Morningstar Short Equity HF PR USD	1.01	-3.64	0.33	-2.35
Morningstar US Equity HF PR USD	-3.47	1.11	-2.07	-4.43
Morningstar US Small Cap Eqty HF PR USD	-4.72	-0.82	-3.39	-8.70
Morningstar Hedge Fund of Funds PR USD	-2.14	2.06	-1.40	-1.52
MSCI World USD	-7.71	-0.74	-1.25	-9.53
S&P 500 TR	-6.00	-3.25	-0.43	-9.44
MSCI EM USD	-12.59	7.25	-5.40	-11.32
MSCI Europe USD	-10.50	1.43	0.04	-9.18
MSCI AC Asia GR USD	-8.94	3.00	-4.97	-10.87
LB Global Agg TR USD	2.78	1.67	2.04	6.63
LB US Agg Bond TR USD	1.68	0.14	0.34	2.17
All returns are in U.S. dollar terms. Category average and grand average returns: Quarterly and year-end returns are based on hedge funds that reported complete quarterly returns for the first quarter of 2008 as of April 15, 2008.