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Fund Times

Little Escape for Hedge Fund Managers

No sector was spared in October.

The Morningstar 1000 Hedge Fund Index returned its worst monthly performance in history for the second straight month in October. The month's 9.4% loss topped September's 7.9% decline. Hedge funds of funds, as measured by the Morningstar Hedge Fund of Fund Index, fell 9.1%.

No sector was spared in October. Equity, bond, and commodity markets each struggled. There was little escape for hedge fund managers aside from holding cash.

The Morningstar 1000 Hedge Fund Index was also affected in October by the U.S. dollar's strength. As an unhedged index, the Morningstar 1000 Hedge Fund Index benefits from weakness in the dollar caused by appreciation in the currency of its non-dollar assets, and is hurt when the dollar rises. In October, the dollar recorded its largest monthly gain in 16 years against a basket of six other major currencies. This increase was responsible for about one third of the Morningstar 1000 Hedge Fund Index's decline.

In contrast, the Morningstar Composite Hedge Fund with MSCI Indexes, which hedge U.S. dollar exposure, suffered a smaller loss of about 4%. As announced in September 2008, Morningstar is also now calculating hedge fund indexes by applying the MSCI Hedge Fund Index Methodology and Hedge Fund Classification Standard to Morningstar's hedge fund database. These indexes demonstrate the performance of hedge funds to investors who have hedged their currency exposure back into U.S. dollars. The MSCI Hedge Fund Index Methodology classifies hedge funds by investment process, geography, and asset class.

The rise of the dollar stemmed from investors looking for a safe haven in U.S. Treasuries, even though the global financial crisis originated in the United States. Emerging markets, on the other hand, saw their worst month in a decade, as foreign investors liquidated assets in emerging markets to beef up balance sheets at home. The Morningstar Emerging Markets Equity Hedge Fund Index declined 15.4% and the hedged Morningstar Emerging Markets with MSCI Hedge Fund Index declined 10.5% in October.

Hit even worse than emerging markets, the Morningstar Convertible Arbitrage Hedge Fund Index lost 16.6% in October. These losses reflect the risk of financial company issuers who were the worst affected by the credit crisis and issued the bulk of convertible bonds in 2008. Adding fuel to the fire, issuance has dried up since mid-year and credit is tight, forcing leveraged convertible arbitrage funds into the downward liquidity spiral of falling asset prices, margin calls, and more liquidations.

Merger and acquisition activity, although rising in October because of government bailouts, set a record for most withdrawn deals according to data provider Dealogic. The Morningstar Corporate Actions Hedge Fund Index, which includes merger arbitrage funds as well as activist funds and those that bet on corporate restructurings, dropped more than 10.6%. These funds generally track equity market sentiment.

Equity hedge funds also took a beating, although they outperformed the markets. The Morningstar U.S. Equity and Small Cap Equity Hedge Fund Indexes fell 10.9% and 14.0%, respectively, while the S&P 500 and Russell 2000 Indexes dropped 16.8% and 20.8%, respectively. Similarly, the Morningstar Europe Equity and Developed Asia Hedge Fund Indexes declined 9.5% and 7.4%, while the MSCI Europe and MSCI All Country Asia Indexes lost much more, 21.3% and 18.7%, respectively. Equity arbitrage funds hedged much of their market exposure, as the Morningstar Equity Arbitrage Hedge Fund Index dipped only 4.0%.

The boon came to equity managers who shorted the market. The Morningstar Short Equity Hedge Fund Index gained a whopping 10.8%, its best month ever. Other refuges in the economic hurricane were the Morningstar Global Trend Hedge Fund Index and Morningstar Directional Trading with MSCI Hedge Fund Index that profited from the downward trends in commodities, namely gold, crude oil, copper, and wheat, and upward trends from the U.S. dollar.

 Morningstar Hedge Fund Index Performance ( % )
 

 

Oct 2008
Return
YTD
Return
12-Mo
Return
Morningstar 1000 HF PR USD   -9.41 -21.36 -22.45
Morningstar Hedge Fund of Funds PR USD   -9.06 -21.27 -22.20
Morningstar Hedge Fund Category Indexes        
Morningstar Convertible Arbitrage HF PR USD   -16.57 -27.88 -30.06
Morningstar Corporate Actions HF PR USD   -10.67 -26.91 -27.85
Morningstar Debt Arbitrage HF PR USD   -9.99 -18.40 -18.88
Morningstar Distressed Securities HF PR USD   -7.07 -17.25 -17.88
Morningstar Dvlp Asia Equity HF PR USD   -7.40 -24.86 -27.69
Morningstar Emerging Markets Equity HF PR USD   -15.43 -42.02 -43.11
Morningstar Equity Arbitrage HF PR USD   -3.97 -6.72 -6.66
Morningstar Europe Equity HF PR USD   -9.49 -20.28 -21.43
Morningstar Global Debt HF PR USD   -13.48 -23.91 -24.65
Morningstar Global Equity HF PR USD   -11.67 -29.45 -31.58
Morningstar Global Non Trend HF PR USD   -3.76 -5.80 -4.45
Morningstar Global Trend HF PR USD   2.63 4.99 5.12
Morningstar Multistrategy HF PR USD   -8.77 -19.58 -21.42
Morningstar Short Equity HF PR USD   10.82 13.67 16.37
Morningstar US Equity HF PR USD   -10.85 -23.00 -24.80
Morningstar US Small Cap Eqty HF PR USD   -13.95 -29.59 -32.01
Morningstar Broad Hedge Fund Cat Indexes        
Morningstar Arbitrage HF PR USD   -7.44 -14.47 -15.00
Morningstar Equity HF PR USD   -11.34 -28.18 -29.98
Morningstar Event HF PR USD   -9.86 -23.46 -25.21
Morningstar Global Derivatives HF PR USD   -1.44 -0.51 -0.39
Select Morningstar HF Indexes with MSCI        
Morningstar HF Composite Asset wtd w/MSCI   -4.05 -12.51 -13.34
Morningstar HF Composite Equal wtd w/MSCI   -4.17 -14.33 -15.58
Morningstar HF Directional Trading w/MSCI   3.27 2.57 3.03
Morningstar HF Dvlp Markets w/MSCI   -3.04 -10.00 -11.20
Morningstar HF Emerging Markets w/MSCI   -10.48 -29.77 -30.13
Market Indexes        
S&P 500 TR   -16.79 -32.84 -36.10
Russell 2000 TR USD   -20.80 -29.02 -34.16
MSCI World USD   -19.05 -39.75 -43.10
MSCI EM USD   -27.50 -54.20 -57.35
MSCI Europe USD   -21.32 -46.91 -49.62
BarCap Global Aggregate TR USD   -3.69 -4.11 -2.57
DJ AIG Commodity TR USD   -21.28 -27.59 -26.61
MSCI AC Asia USD   -18.73 -44.55 -48.59

All returns are in U.S. dollar terms. For the Morningstar Hedge Fund Indexes, assets are based on hedge funds that reported performance as of Nov. 17, 2008. For the Morningstar Hedge Fund Indexes With MSCI, assets are based on hedge funds that reported performance as of Nov. 14, 2008.

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