In a year marked by high volatility in the financial markets, the 10 strategies tracked by the Credit Suisse/Tremont Hedge Fund Index outperformed major global equity indexes and experienced lower volatility than the overall markets.
According to research released by Credit Suisse, the CS/Tremont Hedge Fund Index returned 12.1% with volatility of 1.5% for the year-to-date through November 30. The MSCI World index gained 8.6% with volatility of 2.7%, the S&P 500 stock index gained 6.2% with volatility of 2.9%, and the Tokyo Stock Price Index lost 2.1% with volatility of 2.1%.
In the report, Credit Suisse cited four major events throughout 2007, each of which affected financial markets and tested the stability of hedge funds. While no single hedge fund strategy in the broad index sustained a position in the top performance quartile for the whole year, some capitalized on the turmoil to deliver positive returns in tumultuous markets and keep the overall index afloat.
In late February, concerns about Chinese authorities taking action to curb financial speculation triggered an almost 9% plunge in Chinese equities in a single day. Although fears of an Asia crisis reminiscent of 1997 followed, the first quarter of 2007 was profitable for nine out of the 10 hedge fund strategies tracked by the broad CS/T Index.
This summer, several high-profile hedge funds that invested heavily in securities tied to subprime mortgages collapsed, prompting a credit crunch that struck many big financial institutions. Rallying off strong global stock performance in early summer–the DJIA rose steadily through mid-July to reach more than 14,000 after a late-April high of 13,089–the CS/T Index returned 5.2% over the second quarter. In addition to strong stocks, many hedge fund sectors rallied on strong mergers and acquisitions activity and a positive overall economic outlook.
The third event was the statistical arbitrage sell-off caused by the need for bank proprietary trading desks and hedge funds to de-lever and then liquidate their positions due to investors’ uncertainty in a difficult third quarter. Accordingly, hedge fund strategies varied widely in their performance. Indeed, the CS/T index lost a combined 1.53% for the month of August, though short-selling funds initially capitalized on declining credit markets. Equity market neutral funds using stat arb suffered, as crowded trades caused widespread losses among quantitative funds with the same small-cap and midcap stocks in their portfolios. On the other hand, emerging markets, with limited credit market exposure, gained 5%. Overall, the CS/T Index was up 1.1% amid the turmoil.
The final major event was the return of the credit crunch. In November stock markets suffered their worst monthly performance in recent years as investors reacted to the U.S. housing downturn and the fear that the credit crunch increased the possibility of a recession. Global stock markets slipped as nearly $40 billion in paper losses was announced at large banks like Citigroup Inc. and Merrill Lynch & Co. However, all 10 hedge fund strategies in the broad CS/T index were in positive territory, and the index gained a combined 2% for the fourth quarter through November. Convertible arbitrage funds were flat, with a 0.5% gain.
In conclusion, despite increased borrowing rates, hedge fund financing is still available and allows for leveraging of positions in pursuit of alpha. While some hedge fund strategies suffered during 2007, “others capitalized on market turmoil, thereby more than compensating for the negative impact,” according to the report. Hedge fund strategies benefit from the diversification of a multi-strategy index like the broad index.