Hedge Funds Down In December and 2002

Though hedge funds were down for the month, their performance surpassed the broad markets, as the S&P 500 Index lost 5.90%, the Dow Jones Industrial Average fell 6.23% and the Nasdaq Index decreased 9.69%, according to the Hennessee Hedge Fund Advisory Group.   However, December’s negative return is in contrast to the  2.55% gain posted in November .

For 2002, hedge funds were down 3.43%, the first negative year since the Hennessee Group began monitoring hedge funds in 1987.  Regardless, hedge funds were still the belle of the ball as they handily outperformed the broad US equity markets for the year.   2002 saw the Dow Jones Industrial Average drop 16.76%, the S&P 500 decline 22.19%, and the Nasdaq plummet 31.52%.  Mutual funds were also not immune to the decline bug of 2002, as Lipper Mutual Funds were down 18.77% for the year.

“With market volatility extremely high and the broad markets suffering 5% plus losses, hedge funds proved their value added once again by posting a slight loss for December,” said Charles Gradante, Managing Principal of Hennessee Group LLC. “This downside risk management is further evidenced by the yearly figures for 2002.  The average hedge fund beat the broader indices by 20%,” added Mr. Gradante.

Hedging Bets

December continued to cause problems for hedge fund managers as the Volatility Index (VIX) once again averaged above 30 for most of the month while market conviction and sentiment declined. 

However, taking advantage of December’s decline were Short Biased hedge fund managers, posting a 3.05% return for December. 

Taking the silver medal in December were Latin America managers posting a third straight positive month with a 2.90% return.   Despite turmoil in Venezuela, these managers were able to ride the wave of Brazilian and Argentine market rallies of 9% and 15% respectively.  December’s third best performing hedge fund managers were Distressed managers, posting a 2.77% return as spreads seemed to stabilize and the default rate in high yield debt continued to trend lower.

On the down side, several political and economic factors affected the performance of Long/Short Equity managers in December.  Market uncertainty, spurred by the announcement of a 6% unemployment figure and the weakest holiday shopping season in thirty years, was intensified by the possible increase in energy costs due to the turmoil in Venezuela and the looming prospect of war with Iraq.  As a result Opportunistic managers fell by 3.53% and Growth managers were off by 2.64%.  Additionally, after two strong, positive months, Healthcare/Biotech managers fell 2.67% as many high beta biotech names sold off with the rest of the market.

Looking ahead Gradante says, “in 2003, the best performing hedge fund managers will be those that effectively negotiate a market characterized by low conviction and high volatility.”