NEW YORK - First, the bad news. Only about one-third of the 195 hedge fund managers who submitted September performance numbers to Managed Account Reports LLC showed positive returns. Likewise, only 10 of 33 hedge fund strategies in the Hedge Fund Research Inc. monthly performance indexes were positive in September.
But the good news is that overall, hedge fund strategies still outperformed mutual funds and the broader stock market indexes in September. The Standard & Poor's 500 stock index was down 8.1% in September. The Dow Jones industrial average fell 11.1%. The Lipper Inc. mutual funds index was down 10.8%.
Meanwhile, the Hennessee Hedge Fund Index, a measure of 525 hedge fund managers in 23 strategies, was down 2.04% in September. Hedge Fund Research's fund-weighted composite index was down 1.7% in September.
Some strategies not only buffered poor market returns, but also turned in positive returns.
The $187 million Navy-Marine Corps Society Relief Fund, Arlington, Va., has 18% of its assets in three market-neutral hedge fund strategies run by Numeric Investors LP, Cambridge, Mass.; Salus Capital Management, Los Angeles; and Standish Mellon Asset Management Co., Boston, said James L. Koltes, chairman of the fund's asset allocation committee. Together, those strategies produced a 1% return in September, Mr. Koltes said.
September was an important month for hedge funds in other ways. Although rumors of massive hedge fund blowups circulated through the industry, when it came down to it, few people could name names. It stands to reason some hedge funds lost money, either because their strategies performed poorly or because their sector bets didn't pay off.
Digital Century Offshore Fund Ltd., New York, is a $37 million long-short equity hedge fund that invests in technology stocks. In September, its founder, Rajiv J. Chaudhri, reported to Managed Account Reports that his fund lost 28.5%. When asked to comment, Mr. Chaudhri said he does not talk to the press.
Value was hard hit
First Quadrant LP's market-neutral hedge fund strategy lost 1.5% in September, said Robert D. Arnott, managing partner. That's because Pasadena, Calif.-based First Quadrant's market-neutral strategy has a bias toward value stocks, and value didn't do well in September.
"Value got hit hard because value tends to mean things like banks, insurance, airlines, things with decent price-to-book value and so forth," Mr. Arnott said. "So any market-neutral strategy that had a value spin clearly would have been hurt by the events of last month."
Mr. Arnott quickly added that September's losses came on the heels of two successive months of positive 5% returns.
Other hedge funds had to liquidate stock to meet margin calls. Several people and at least one published report said the Bass family of Fort Worth, Texas, had to sell a large number of shares of The Walt Disney Co. to meet such a margin call.
But there were no new complete meltdowns, a la Long Term Capital Management in 1998. That's significant, observers say, because it shows many hedge fund managers, keenly aware of the lessons of LTCM, ratcheted down their leverage and lessened their losses.
Additionally, many hedge fund managers and fund-of-funds managers said September was a month that separated quality managers from average or poor managers. In long-short equity hedge fund strategies, for example, managers who were not properly hedged with short positions prior to Sept. 11 had a hard time shorting their positions when equity markets reopened Sept. 17.
Whipsaw effect
"It was a period which really separated the men from the boys," said Damon Mezzacappa, founder of hedge fund-of-funds manager Mezzacappa Management LLC, New York. "Some funds we've been with for a while got banged around pretty badly."
Mr. Mezzacappa would not discuss individual fund performance.
It wasn't just the steep declines in equity market indexes the week after the Sept. 11 attacks that killed some hedge fund managers, either. At the end of the month and into October, the markets rebounded. Computer equipment manufacturer Cisco Systems Inc., San Jose, Calif., saw its stock price jump 20% on Oct. 3. Mr. Mezzacappa said the whipsaw effect would have hurt hedge fund managers with a technology focus that had previously shorted Cisco stock.
"If you were short Cisco (on Oct. 3), you lost 20% in a day," he said.
In general, equity long-short strategies, short-biased strategies, fixed-income strategies and convertible arbitrage strategies turned in decent September performance. According to The Hennessee Group LLC hedge fund indexes, short-biased strategies returned 10.7% in September, nearly 10 percentage points higher than the next-best returning strategy, convertible arbitrage. Year-to-date through Sept. 30, short-biased hedge funds are the best performers in the Hennessee index, with a 15.8% return.
Short sellers do well
Similarly, short sellers had good September returns in the Hedge Fund Research performance indexes, turning in a 3.16% gain, second only to hedge funds focusing on the energy sector. Year-to-date through September, short-biased strategies are leading all strategies with a 21.07% return.
Those numbers show that short-only strategies not only performed well in September, but have been doing well all year - which isn't surprising, said William Jacques, chief investment officer at Martingale Asset Management LP, Boston, which runs $300 million in a long-short equity market-neutral strategy.
September's market moves, he said, "just accentuated movements that were already taking place."
In other words, the market had been deteriorating all year, and short sellers were reaping the benefits of falling stock prices. But at the same time, another interesting thing was taking place. As the market continued to decline, more equity hedge fund managers, worried the market was nearing its bottom, started keeping assets in cash, said one hedge fund-of-funds executive, who asked not to be named.
"A lot of long-short equity guys have been heavily in cash for some time because they've seen deteriorating fundamentals," the executive said.
Calling the drop
Langdon Wheeler, president and chief executive officer of Numeric Investors, said one of the three quantitative models his company uses to analyze market information showed the economy trending toward recession all year. Mr. Wheeler said despite this, the market kept responding positively to U.S. Federal Reserve Board interest rate cuts. Finally, after the Sept. 11 attacks, the market dived in the direction Mr. Wheeler's estimate trend model had been predicting all along.
"What happened was the market was already trending toward recession, then it got slammed with a series of very recessionary events," Mr. Wheeler said. "The market finally gave in to accept this economic pattern."
