Amid the sovereign debt crisis, high volatility and deteriorating economic conditions, hedge fund performance in 2011 was the worst since the financial crisis began, according to multiple hedge fund indices.
The Hennessee Hedge Fund Index dropped 4.3 per cent, the Bloomberg Hedge Fund Index fell 4.9 per cent and the Eurekahedge Index declined by 4.1 per cent in 2011.
Compared to the flat performance of the S&P 500, it is the second consecutive year hedge funds were unable to outperform equity indices. Although 2011 started positively for most hedge funds, the second half of the year represented enormous challenges for fund managers with extreme volatility in the markets and macroeconomic factors, such as the European sovereign debt crisis, overshadowing strong corporate earnings and an improving economy in the US and parts of Europe.
Charles Gradante, co-founder of Hennessee Group, said fund managers had characterised 2011 as “more frustrating than 2008”. According to the firm, many funds had reduced their risk exposure and moved into cash in the fourth quarter, limiting their potential to benefit from a strong year-end rally when specifically in October equities saw a double digit increase.
Among the various hedge fund strategies Hennessee’s Global/Macro Index was one of the poorest performers, losing 8 per cent in 2011. The Emerging Markets Index fell even further, dropping by 12.9 per cent as market uncertainty impacted emerging market equities last year.
The Eurekahedge Asian Hedge Fund Index dropped 8.3 per cent, the second-worst performance since 2000, when the Singapore-based data provider started keeping records. In addition, the highest number of Asian funds since the 2008 financial crisis closed down.
The Hennessee Macro Index fared comparatively better losing only 2.1 per cent and benefitting from the funds’ conservative positions in Treasuries and gold.
Household names such as John Paulson, who in 2008 gained notoriety from his successful bets against the subprime mortgage market, were among the biggest losers in 2011. Last year, several Paulson funds suffered double digit declines and the flagship Paulson Advantage Plus Fund lost 51 per cent for the year with bets on a rebounding economy.
According to Chicago-based Hedge Fund Research, hedge funds hold about $1.97 trillion in assets and the average hedge fund fell 4.45 per cent in 2011 through 15 December.
The year showed that the notion of absolute return, in other words that hedge funds are able to generate positive return irrespective of the general market conditions, is not accurate. However, institutional investors are not expected to redeem and desert hedge funds in 2012, given that positive returns are difficult to achieve through other investment forms in the current market environment. Overall, the size of the industry has reached the pre-crisis 2006 levels.
Ken Heinz, president of Hedge Fund Research, said equities were the weakest performers last year, but funds that are active in arbitrage have actually posted gains. He said he believes the European debt crisis will have to be resolved positively or negatively this year and as a result opportunities will emerge for hedge funds across all asset classes.
“2011 has been dominated by the Euro crisis oscillating between risk on and risk off trades and I expect in the early part of the year  we are going to see some resolution of that trade and the dislocations which are going to come from that, the positive or negative, are going to create a tremendous amount of opportunity,” he said.
The favourable outlook is shared by Hennessee Group.
“Despite the performance struggles, we are optimistic on the outlook for the hedge fund industry,” said Lee Hennessee, managing principal of Hennessee Group. “Hedge funds continue to attract capital due to their historical performance and ability to lower volatility and preserve capital. In addition, most investors understand the challenges for fundamentally-based managers in a macro driven market, and are confident they will not persist.”