Hedge fund net outflows continued in March, however, the rate of redemptions slowed for the third straight month, after outflows peaked in December. Hedge fund assets fell 1% in March to $1.7tr compared to a drop of 2.51% in February and 7.5% in January, according to HedgeFund.net (HFN). While the hedge fund industry has contracted 41% from the asset peak level in June 2008, the industry’s performance has picked up.

This positive performance was mostly driven by surging global equity markets, but the fact that long only strategies were well below broad equity indices is an indication managers maintained a cautious approach. “The biggest drag on performance, apart from short-biased funds, was CTA/managed futures products focusing on foreign exchange markets. The announcement on March 18 that the US treasury would significantly expand its balance sheet resulted in sharp exchange rate movements which negatively impacted many of these managers” notes HFN.

Other strategies that continued to struggle in March were distressed securities, falling 4.39% and equity market neutral which posted a loss of  less than 1%, according to Dow Jones Hedge Fund Indexes. The majority of hedge fund strategies, however, saw a bright spot during the month, gaining 2.41%, according to BarclayHedge.  Overall, 15 of Barclay’s 18 hedge fund indices gained ground in March. The biggest gainers were emerging markets (4.74%), equity long bias (3.51%), technology (3.2%), Pacific Rim equities (2.65%). “Emerging market funds did exceptionally well in March, driven by double-digit returns in the equity markets in Brazil, Russia India and China,’ says Sol Waksman, president of BarclayHedge. “With the sudden upturn in equity markets, equity long bias had its strongest one-month performance since gaining 4.72% in January 2006.”

Lag broader equity indexes

Other indexes show hedge funds making smaller gains. The Hennessee Hedge Fund Index returned 1.37% for the month while the S&P advanced 8.54% and Nasdaq 11%. “It was a challenging month for hedge funds,” notes Charles Gradante, co-founder of Hennessee Group. “Most were caught with tight net exposures and unable to participate in the rally. Managers were also hurt as the sectors they have been heavily short, such as financials, consumer discretionary and material, were the sectors that rallied the strongest.” The financial sector has been a beneficiary of profitable operating earnings in the first two months of the year and increased government programs to provide liquidity to the banking system.

Yet hedge funds have outperformed the broader equity indexes so far this year. The strongest-performing hedge fund strategy year-to-date (end of March) is convertible arbitrage, with an 11.3% increase compared to a 28% loss in 2008, according to BarclayHedge. One explanation for this out-performance: the convertible arbitrage segment has become less crowded as a number of banks shut down their convertible arbitrage trading desks last year and in the process came under pressure to unload their inventory.

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