By Laurence Fletcher
LONDON (Reuters) - Hedge funds are braced for more dire performance data after sharp reversals in commodities and financials in July pushed some funds to record losses -- making the goal of positive returns for the year even harder to reach.
Like the market swing in March following the bailout of Bear Stearns, the spike in volatility in July caught many funds by surprise as two of their favourite bets -- long commodities and short financials -- simultaneously unwound.
Hedge funds can in theory make money during periods of high volatility, but the losses in July shows how even these skilled market operators can be caught out by sudden market changes.
Hedge Fund Research's HFRI Monthly index was down 2.35 percent in July. Other index providers are set to report similarly poor numbers next week.
"It was a properly difficult month," said BlackRock (BLK.N: Quote, Profile, Research) fund manager Mark Lyttleton. "If you're highly leveraged, you're going to be losing a lot of money very quickly.
"There's one or two hedge funds that I look at (that) I would imagine at certain points of the month were down 10 to 15 percent, and one of them, which is a good one, was down 7 (percent) in a month, which is the worst month they've ever had," Lyttleton said,
Funds which owned soaring commodities and shorted battered financials in the expectation of further price falls have profited in recent years. John Paulson for instance, the top-earning manager in 2007 with $3.7 billion, has been short financials.
However, the suddenness of the drop in commodities and recovery in financials in July resulted in heavy losses for many funds who were betting against such moves.
During July the FTSE All Share Banks index .FTASX8350 jumped 5.8 percent, including three days of gains or more than 6 percent. Large-caps such as Royal Bank of Scotland (RBS.L: Quote, Profile, Research) and Barclays (BARC.L: Quote, Profile, Research) twice jumped more than 10 percent in a day.
In contrast the FTSE All Share Mining index .FTASX1770 fell 13.1 percent, including five days when it fell by more than 4 percent.
DIFFICULT MONTH
"We suspect it will have been a very difficult month for the hedge fund industry," said Cazenove fund manager Tim Russell in a note to investors. "There was significant mean reversion in sector performance."
The sterling share class of his UK Equity Absolute Return fund rose 1.3 percent over the month, but only after gaining nearly 3 percent after the first seven trading days before seeing its biggest drawdown -- peak to trough performance -- since launch in the remaining three weeks.
The reversals echo those seen in March, when bets that financial stocks would fall backfired, as the sector jumped on hopes the U.S. Federal Reserve's bailout of Bear Stearns meant large banks would not be allowed to go bust.
In contrast to hedge funds, long-only funds will generally have benefited from a rebound in bank shares, even when their commodity holdings are falling.
"It's clearly been a tough month for people investing in these areas," said Craig Asche, executive director of the Chartered Alternative Investment Analyst Association.
"We'd love to see all hedge funds in positive territory but it's been a difficult environment."
The $2.6 trillion hedge fund industry, which is meant to be able to make money in all market conditions, could be on course for only its second calendar year of negative performance since 1990 -- a significant result in what has until recently been a red-hot asset class.
Hedge Fund Research's HFRI index is down 3.54 percent for the first seven months of the year.
However, not everyone is panicking.
"It's only one month so let's not get carried away by this," said BlackRock's Lyttleton.
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