The January markets rally has affected 2005’s opening figures for many categories of hedge fund. Data revealing strong foreign demand for US assets had calmed fears that the US will struggle to fund its ballooning trade deficit. Instead, investors have focused on dollar-positive factors. Going forward, it is the threat of a dollar rally that heralds dark clouds on the horizon for 2005, particularly for directional strategies such as macro and equity long/short funds. It could threaten the asset reflation trade which Asia/Pacific equities have benefited from since May 2004, as well as clear out many smaller funds that jumped on the currency trend bandwagon too late, hoping to capitalise on the range-breaking decline of the dollar in November.
While analysts argue over the fate of the dollar, the general macro outlook for 2005 remains positive. With leading global indicators in decline since February 2004, there is the possibility that growth in 2005 could be stronger than expected. Managers expect to position themselves for continued imbalances in the global economy, higher volatility and decreased visibility in the markets. An encouraging sign was the much better fourth quarter for hedge funds, registering as a broad sector their best results since 2003. But it wasn’t enough to rescue a disappointing year by recent standards, especially when compared to mainstream equity markets. The Van Global Hedge Fund Index showed a 7.7% gain net of fees for 2004, the returns for the year dragged down by a lacklustre showing in the spring and summer.
According to Van Hedge, performance relative to the markets in 2004 fits the established pattern. Over the past ten years, with the exception of 1999, in those years when the S&P 500 has been positive, the Van Global Hedge Fund Index has also been positive but produced a lesser gain than the S&P 500. In those years when the S&P 500 has fallen, however, the Van Global Hedge Fund Index has outperformed, posting a gain despite broad stock market losses.
For 2004, Distressed Securities strategies were consistently the most profitable, earning 18.2% net, continuing the run of 2003 when distressed securities produced a 27.4% net gain.
Emerging Markets ranked second in 2004, generating a 13.3% net gain for the year. Value, a long/short equity strategy, had the third highest return, gaining 11.6% net in 2004. Short Selling was the one strategy to post a loss for the year, down -9.3% net.
The four arbitrage sub-strategies tracked by VAN were all positive both for December and for the full year.
Fixed Income Arbitrage, which sustained no losing months during the year. Statistical Arbitrage gained 3.2% net for the year. Merger Arbitrage, a strategy that has languished since 2000 due to diminished deal flow, edged up 2.8% net for the year. Convertible Arbitrage, the most widely employed type of arbitrage, had a difficult year in 2004. Rather than its usual double-digit annual return, the average Convertible Arbitrage fund gained just 1.0% net last year, with 0.6% net coming in December.
For the Asian hedge funds universe tracked by Eurekahedge, distressed debt and emerging markets were similarly positive. The increase in merger and acquisition activities in Asia drove gains for event-driven strategies.
Increased global corporate activity has also benefited both event-driven and distressed debt funds, by increasing debt restructuring opportunities.
On the other end of the spectrum, funds which had bounced back in November from poor returns in the preceding month, failed to retain their burst of cheer, and posted disappointing December results. CTAs lost previous gains on short dollar positions and strong Asian currencies, sinking into the red at -0.13% returns. Decreased volatility in the markets and a slide in commodity prices had much to do with this unimpressive showing.
Directional strategies such as macro and equity long/short, which had cashed in on some developing trend patterns in November to lead the pack with impressive 4.38 % and 3.33 % returns respectively, also posted comparatively poorer returns in December.
This reflected the impact of the dollar’s range-breaking decline in November, which lifted returns in the month to record highs for the year. However, Asian and European equities were generally positive for the month, despite declining markets in China. This ensured equity long/short strategies remained just behind the distressed
debt and event-driven funds with 1.41% December returns.
The Eurekahedge Asia Hedge Fund Index posted the largest gains of the year in November at 3.03% but could not repeat these gains by the close of the year, recording returns of only 1.19 % in December’s flash update.
The slowdown in the ex-Japan region to a 1.56 % gain was offset by an increase in the Japan Index to 0.74 %, a rise that was brought about by a sharp rallying of Japanese markets by 4.7 % in December.

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