Stocks outperformed hedgies last month

Hedge funds were unable to keep pace with the broader equity markets last month, but did maintain their slight performance edge over stocks through the first 10 months of the year. The Hennessee Hedge Fund Index gained 1.9% in October, which compares to a 3.7% gain by the S&P 500 Index. Year-to-date through October, the hedge fund index was up 6.7%, while the S&P was up 6.1%. “The financial markets continued to rally as the companies reported solid earnings and the Fed announced an additional round of quantitative easing,” said Hennessee Group co-founder Charles Gradante. “Hedge funds posed strong positive performance, but lagged traditional benchmarks due to conservative exposure levels and losses from hedges.” Mr. Gradante emphasized the presence of high correlation and a “risk on/risk off” trade that is making it difficult for most hedge fund strategies to apply fundamental analysis and investing techniques. “Until we see fundamentals return to the forefront of investing, we believe hedge funds will have difficulty executing their investment strategy, particularly on the short side,” he said. Hedge fund managers generally view corporate earnings and equity valuations as positive and believe equities could trend higher in the near term, Mr. Gradante said. He added, however, a lot of hedge fund managers have been conservatively positioned this year because of the market environment and longer-term economic head winds. “Managers believe that the second round of quantitative easing [announced last week] is bullish for the financial markets, at least through year-end,” Mr. Gradante said. “However, once the Fed stops easing, the music will stop.” There is the possibility of a new financial crisis, perhaps in the interest rate swaps market, Mr. Gradante warned. “History shows that you cannot implement an extreme policy, in this case monetary easing, and manipulate the free market, such as yield curve, without causing someone to be [left] holding the bag with policy changes,” he said.