General market performance

Hedge fund performance

After an uneventful start to the year, the first signs of weakening appear in the US housing market. Several mortgage lenders go out of business or declare bankruptcy. At first, financial markets deem these problems to be isolated. Most equity indices continue to rise.

All hedge fund styles post positive returns. Global macro and managed futures strategies are the clear winners, with event driven also doing well as corporate activity remains strong.

Problems in the subprime mortgage sector began to spill into the wider credit markets in July, triggering a global repricing of credit risk. With credit markets essentially closed, banks are no longer willing or able to lend to each other. Overnight, lending rates soar. Central banks around the world inject liquidity to maintain market stability. Volatility returns with a vengeance.

Hedge funds generate a wide range of returns during the quarter and are highly dispersed. Quantitative trading strategies suffer substantial losses: some are forced to scale back market exposure, thereby missing out on the recovery when the Fed ’rescues’ the market in mid August. Other strategies are less affected, but the lack of liquidity and huge sell-off in mid August lead to widespread losses. While August is the worst month of the year for many funds, September is the best to date, with some funds (notably managed futures, a strategy favoured by Man) making up their losses. Overall, hedge funds in aggregate post a small positive return.

The quarter starts on a positive note as equity markets recover from their August lows. The S&P 500 marks all time highs in early October as the September Fed interest rate cut appears to provide the US economy with the necessary stimulus. However, the outlook worsens in November and December as investment banks announce billion dollar write-downs linked to exposure to subprime mortgages. As the equity and credit markets sell off briskly, commodity prices strengthen. Emerging markets hold up well despite a slowdown in more developed countries.

October is the best month of the year for many hedge funds, as all styles benefit from rising Asian equity markets, growth stocks and commodities. November and December are difficult, but most hedge funds are able to preserve capital or keep losses small. In aggregate, most diversified funds of hedge funds provide the necessary downside protection during the quarter. Hedge funds in aggregate post another small positive return.

2008 starts with a period of extraordinary market turmoil. The near collapse of Bear Stearns in March marks the spread of the credit crunch to the heart of the US financial system. Worldwide, banks write down billions of dollars of assets and policy makers consider a range of options to restore orderly markets. The IMF lowers its forecast for global GDP to 3.7%, the lowest since 2002. While the outlook for the US economy remains weak, the outlook for emerging and some European markets remain relatively robust.

Although the credit crunch claims a number of high profile hedge fund victims and hedge funds in aggregate post a loss in the quarter, they continue to outperform other asset classes, with the managed futures strategy providing excellent diversification. The remainder of 2008 looks set for further periods of uncertainty which should, however, give rise to a range of opportunities for skill based investment managers.