Hedge funds higher in August but underperform broad market

Hedge funds were generally up across the board in August though they underperformed the broad market according to Hennessee Group LLC. The Hennessee Hedge Fund Index was up 0.97% in August vs. 1.98% for the S&P 500. Those numbers appear to be following a year-long trend as the index is up 3.82% vs. the S&Ps 11.85%.

“Hedge funds continue to lag equity markets for the year, as many failed to participate in the strong market rally of the first quarter and third quarter,” says Lee Hennessee, managing principal of Hennessee Group, in a press release.

“Hedge funds continue to learn a hard lesson: ‘Don't fight the Fed, regardless of fundamentals’ should be the bumper sticker for this market," Charles Gradante, managing principle of Hennessee Group, adds, “Sitting in cash, being defensive and waiting for the other shoe to drop has been a poor strategy during the last 12 months.”

Despite this Gradante says recent performance has picked up due to increased risk tolerance and a shorter-term outlook.

“Hedge funds benefited from the rally in risk assets, as many funds strategically increased net exposure in July,” Gradante notes. “While hedge funds are mindful of risks related to the ongoing European banking and sovereign debt crisis, they have become more comfortable with the short-term outlook and have increased their risk tolerance.”

Most hedge fund strategies continued a three-month positive trend last month, with long/short equity, credit and event-driven managers performing well, according to the report. Hennessee’s short-biased and Asia-Pacific indexes struggled, however, dropping by -2.80% and -0.87%, respectively.

The S&P was up 1.98% for the month, led by the technology, consumer discretionary and financial sectors. The tech sector was also a strong driver for the NASDAQ, with Apple Inc. alone up 65% for the year. With volatility continuing to decline—and the CBOE Volatility Index (VIX ) hitting 13.45 last month—managers with significant net long exposures and those who were focused on relative value performed well in August, according to the report.

Gradante predicts that more managers will be under pressure to generate performance in the fourth quarter, although many have been reluctant to increase risk-taking before seeing improvement in fundamentals.

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