Hedge Funds Slip in February

The hedge fund industry's performance fell last month, although it has improved so far this year despite more market turbulence.
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Hedge funds stumbled slightly in February after starting off the year with gains, although the industry outperformed the major U.S. stock indices and outpaced a dismal performance in 2008, according to two research groups.

Hedge Fund Research reported on Friday that its composite hedge-fund index slipped 0.51% in February, while Hennessee Group said Monday that its hedge-fund index was down 0.78% last month. When compared with broad market indices, like the

S&P 500's


Dow Jones Industrial Average's

11% declines, hedge funds outperformed by about 10 percentage points.

The missteps last month reverse the gains from January. HFR's composite hedge-fund index rose 0.39% that month, while Hennessee Group said its hedge-fund index was up a sharper 0.9%.

Still, funds are outperforming the broader market, a positive sign after a miserable 2008. Over the first two months of the year, HFR's composite index is down a mere 0.59% and Hennessee Group's index has managed a 0.12% gain, compared with roughly 20% declines on both the Dow and S&P 500.

"Hedge funds were flat the first two months of the year, while equity markets have declined almost 20%," said Charles Gradante, co-founder of Hennessee Group, in a statement. "Hedge funds are doing what they do best, preserving capital in down markets and generating alpha by managing exposures and perceptive stock selection."

Lee Hennessee, managing principal of Hennessee Group, said that conditions continue to improve for hedge funds and that she is encouraged by the positive performance after a challenging 2008.

"Volatility is elevated, but not extreme; dispersion among sectors and securities has increased; and the markets are responding to fundamentals (though negative fundamentals), which is allowing funds to generate profits in their short books," Hennessee said.

The strongest gains last month were made by funds invested in the bond markets, shorting the equity markets, or ones that employed arbitrage strategies. On the other hand, health care and biotech related funds performed terribly in February as fund managers were hurt by their long health care positions after President Obama released his budget proposal, which called for spending cuts and reform.

Even some top funds have had issues with high-profile investments, like Cerberus' stakes in struggling U.S. automakers Chrysler and

General Motors

(GM) - Get Report

, which are relying on government intervention to stay afloat.

Other prominent funds of Citadel, Harbinger Capital, Glenview Capital Management,

Fortress Investment Group





have also suffered and been plagued by investor demands for cash.

Gradante said that there is still a negative overhang from large hedge funds that placed limits on redemptions, and that they are expected to continue selling assets to raise cash for withdrawals. However, there are also some creative ways for investors to gain liquidity from gated funds, he said.

"Most notably, there have been a series of auctions where investors can purchase fund interests in the secondary market at a discount to

net asset value," Gradante said. "This process benefits limited partners as it gives them immediate liquidity. It also benefits the fund as it eliminates the need to sell securities to fund redemptions."