Market jitters affect hedge fund returns

News analysis

By Charlie Corbett
Thu, 19 Apr 2007

Page 1 of 2

The first quarter of 2007 was a mixed bag for hedge fund manager returns.

The first quarter of 2007 was a mixed bag for hedge fund manager returns, according to data released this week by research company Morningstar.

Emerging markets and convertible arbitrage funds came top of the performance league, while managed future funds were hit hard by choppy market conditions.

On the whole, global hedge funds managed to beat both the S&P 500 index and the MSCI World Index in the first quarter, despite February's market volatility.

Hedge funds reported average total returns of 2.1 per cent for the three months of 2007, with most of the gains coming in January.

Despite the global volatility in February and March, where stock markets across the world plummeted, hedge funds returned over 0.5 per cent on average during these months.

Convertible arbitrage funds were among the quarter's best performers with average returns of 4.67 per cent.

"This category, with its long-option return characteristics, benefited from increased volatility during the quarter as well as high levels of convertible bond issuance. Funds invested in emerging markets convertible bonds showed better results," Morningstar said.

Emerging markets funds returned an average of 5.5 per cent with China-focused managers topping the list.

Developed-market equity hedge funds also fared well, according to data from Morningstar, with commodity, Europe and Japan funds taking the lead.

Market jitters affect hedge fund returns

News analysis

By Charlie Corbett

Page 2 of 2

Financial sector funds did not perform so well in the quarter, however, suffering from weakness in the sub-prime lending market.

The financial turmoil proved a bonus for those hedge funds in the distressed companies category.

These funds returned 4.15 per cent in the first three months of the year, with February being the most lucrative month.

Widening spreads and heightened volatility also drove up returns of fixed-income arbitrage funds by 2.17 per cent for the quarter.

Event-driven and merger-arbitrage funds prospered from a flurry of corporate activity, picking up 4.21 per cent and 2.88 per cent respectively.

Not all hedge funds, however, thrived in early 2007.  Equity net neutral funds managed to outperform Treasury bills by a meagre 20 basis points, with average returns of 1.51 per cent.

Global macro funds, a category that includes currency traders, lost 47 basis points as the business of financing higher-yielding assets with lower-yielding currencies took a turn for the worse.

The biggest loser by far, however, was the managed futures category. Choppy markets mean bad times for these primarily trend-following funds, which lost 2 per cent in the first three months of the year.

Morningstar has more than 6000 hedge funds and hedge funds of funds grouped into 15 categories in its database.