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Hedge Funds Moderate Loss

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NEW YORK (–May’s losing streak did not end with that month but appears to have become less damaging, judging from hedge fund index data available so far. The Hedge Fund Research Fund Weighted Composite Index was almost flat in June, with a decline of 0.2%.

By comparison, the MSCI world equity benchmark lost 3.3% and world sovereign bonds gave up 2.7% during the month. We’re beginning the second half of the year and investors have earned little or no return from most financial assets regardless of the currency, wrote Jeffrey Schoenfeld, chief investment officer at Brown Brothers Harriman & Co.

Despite the turmoil of the past two months, the HFRI index is up over 6% year-to-date. That average conceals different patterns, although no hedge fund sector is in the red for the year so far.

For instance, the HFR fund of funds index lost 0.8% in June and is up 4% for the year, whereas a miscellaneous sector index lost almost 3% in June but is still returning 15% for the year. That is consistent with expectations: Typically funds of funds reduce volatility, but sacrifice some return to do that.

Recent performance also is consistent with the expectation that hedge funds should not lose as much as stock and bond markets. At least some hedge fund portfolios are really hedged and the flexibility to go to cash allows risk-conscious managers to moderate losses.

But the results do not support the promise of absolute positive returns in all types of markets, at least not for hedge funds as a whole. Certain strategies did deliver exceptionally strong performance in choppy markets: The HFR market timing index gained 4.4% in June and is up over 12% for the year.

Clearly, if one invests in the right hedge fund strategy, one can make a lot of money even in an environment fogged by uncertainty as to interest rate policy and geopolitical conditions. If one invests in hedge funds across the board, what one gets is less volatility, not high returns.

But was it possible to predict in January that, say, market timing funds were going to do well in the first half of 2006? Will they do as well in the second half?

Economic uncertainties are likely to continue. Mr. Schoenfeld said he is upbeat about the U.S. and global economy, but he pointed to rising core inflation as a reason to expect more rate hikes from the Federal Reserve. Policy unpredictability in the United States is compounded by monetary tightening at central banks across the world, he wrote in a report. As for political risks, a quick look at international news shows that they’re not fading.

Mr. Schoenfeld said he expects greater market volatility and a growing preference for less risky assets. Which strategies perform reliably well in such environments? That’s the key question for investors.

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Contact Bob Keane with questions or comments at [email protected].


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