From the November 2008 issue of Investment Advisor • Subscribe!

November 1, 2008

A Q2 Meltdown

Using words like "violent," "extreme," and "unpredictable," Hennessee Group LLC principals Charles Gradante and Lee Hennessee struggled to describe the staggering September losses experienced by the hedge funds their firm tracks in its Hennessee Hedge Fund Index.

As a whole, the index fell 6.24% in September, its biggest one-month decline in more than a decade. Arbitrage and event-driven managers fared the worst, losing 6.38%, but the red ink was by no means confined to one area. Every single strategy the Hennessee index follows except for short selling lost money in September. Long/short equity managers were down 5.86%, while global/macro managers lost 5.93%.

For the year, hedge funds in the Hennessee index were down 10.28% through Sept. 30--not nearly as bad as the negative 20.57% year-to-date performance of the Standard & Poor's 500 stock index, or the negative 18.2% recorded by the Dow Jones Industrial Average, or the negative 21.51% earned by the Nasdaq Composite Index--but not exactly what hedge fund investors had in mind when they sought out and paid for "absolute returns."

The Effects of Short Selling Ban

"Hedge funds have outperformed on a relative basis year-to-date," said Hennessee, managing principal of the eponymous firm, in a news release. "Violent theme reversals, extreme volatility. and unpredictable intervention have contributed to negative performance."

Part of that "unpredictable intervention," no doubt was the global ban on short selling that went into effect in August, designed to boost markets by preventing bets against certain stocks, mostly in the financial sector. In that it was perhaps a marginal success, although it didn't exactly halt the downward spiral of equity prices. And it had other, more far-reaching effects.

"The ban on short selling caused significant losses across most strategies and required funds to alter their trading models," Gradante said in a news release.

In particular for long/short equity funds, the short selling ban restricted funds' downside protection. According to Hennessee, the intervention caused a large short squeeze while at the same time long positions were hurt by deleveraging and liquidity concerns. After September's losses, long/short funds were down 9.31% year-to-date.

No Thanks to Russia and Brazil

Global/macro managers' loss in September pulled their year-to-date returns down to a negative 12.74%. Within global/macro, international long/short equity managers were down 8%, hurt particularly by emerging markets managers who were down 10.41% thanks, in particular, to troubles in Russia and Brazil.

Macro managers lost money courtesy of a selloff in commodities; they were down 1.73%

"Many macro managers are betting on lower interest rates in Europe," Gradante said. "Currently Europe has an inverted yield curve while credit spreads are widening. This should help force Europe to lower short term rates and steepen the yield curve. It will also help the credit markets."

Reprints Discuss this story
This is where the comments go.