September 11, 2007; Page C2
Hedge funds turned in their worst month in more than a year in August -- as credit-crunch-induced volatility racked markets. And many of the problems were their own doing.
Hedge funds lost 1.3% in August, their worst performance since May 2006 and the first losing month this year, dragged down by losses of about 2% in stocks, emerging markets, junk bonds and so-called macro strategies, or funds that make bets on broad global markets, according to Hedge Fund Research Inc., a Chicago hedge-fund research firm. Funds of funds, or funds that invest in other hedge funds, did even worse, losing 2.1% in August. (See Breakingviews analysis.)
The losses weren't dramatic, but they came as overall markets managed to finish the month in the black. The Standard & Poor's 500-stock index gained 1.5% in August, including dividends, while the Lehman Brothers bond index rose 1.4% in the month.
The data are based on reports from about 40% of hedge funds. The rest have yet to call in their numbers, raising questions about whether their results are still worse -- the best performers generally are more eager to quickly own up to their results than troubled funds.
Ken Heinz, president of HFR, noted that many hedge funds trimmed their losses late in the month when many "quantitative" funds, or those that trade based on computer models, staged an impressive turnaround. Still, the losses undermined the argument of hedge funds that they are able to generate profits in all kinds of markets.
The year does remain a positive one so far. Hedge funds gained 6.2% through August, beating the overall market by about one percentage point. In July, hedge funds were able to gain ground, even as the stock market slipped a bit. And some investors expected August to have been an even harsher month for hedgies than it was.
Funds added about $17 billion in assets in July, bringing their total assets under management to $1.76 trillion, according to HFR. It isn't clear if their popularity continued in August, though -- some expect the month to be one of the first to show nervousness about funds on the part of investors.
Still, the growing size of hedge funds was a big reason they did so poorly in August. As the subprime meltdown caused nervousness on Wall Street, a number of hedge funds last month slashed their leverage, or borrowings, to become more cautious, or under pressure from their lenders. That forced them to pare their holdings. Because so many growing hedge funds embraced similar stocks in recent months, when they turned to sell it put extra pressure on holders of these shares -- fellow hedge-fund managers.
To wit, the 20 stocks in the S&P 500 with the highest hedge-fund ownership concentration have tumbled 16% since June 30, compared with a loss of just 3% for the S&P 500 as a whole, according to Goldman Sachs. Concentration is defined as the percentage of a company's market value that is owned by hedge funds.
"Concentrated hedge-fund holdings dramatically underperformed during the recent selloff," said David Kostin, an analyst at Goldman Sachs, in a recent report.
These stocks include Sears Holdings, Borders Group Inc., Wendy's International and Carmike Cinemas. Hedge funds own more than 40% of these shares, as of the end of the second quarter. That has set up some opportunities, Mr. Kostin and others argue, because the selling was due to the de-leveraging, not because of reduced earnings expectations or other fundamental factors that usually weigh on shares.
"Buy these stocks which have dropped due to ownership composition, not necessarily fundamentals," Mr. Kostin said.
It's also made some hedge funds more wary of buying shares of companies that fellow managers own, traders say.
Hedge funds could see "another shoe" drop in the months ahead if investors withdraw money, forcing them to do more selling, says Charles Gradante, co-founder of the Hennessee Group LLC, a hedge-fund advisory group that estimates that hedge funds fell 0.7% in August. Sixteen of the 23 strategies the firm follows lost money in the month.
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