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Hedgeweek Commentary: Behind the hedge fund news

With the industry recording its poorest performance in the first half of a year since records were kept, according to Hedge Fund Research, hedge fu

With the industry recording its poorest performance in the first half of a year since records were kept, according to Hedge Fund Research, hedge funds are the worst asset class to be invested in right now … apart from all the others. While preliminary index results are suggesting that the average hedge fund is down by something less than a percentage point in 2008 so far, US and global equities have lost more than 10 times that amount. Investors may not find it much of a consolation, but they should – as an asset class, hedge funds are demonstrating their ability to preserve capital in tough economic times.

Hedge funds still outperform broader markets

The ongoing market turmoil has left few survivors in its path of financial devastation with financial institutions, corporates and regulators all hard hit. It should come as no surprise that hedge funds delivered their worst first-half performance on record during the first six months of 2008.

As a group, hedge funds declined by 0.68 in June, and their decline so far this year is now 0.75 per cent, according to industry tracker, Hedge Fund Research – worse than any comparable period since HFR started tracking returns in 1990.

However, the decline is much less painful that that of other asset classes. During the first half of the year, the 30-stock Dow Jones Industrial Average fell 14.4 per cent, while the broader S&P 500 declined 12.8 per cent.

Despite the difficult market climate, hedge funds still appeal to investors. During the first quarter, hedge funds attracted USD16.4bn in net assets. While that might be down from USD60.2bn a year earlier, it indicates strong investor faith in a dismal economic environment.

With the onset of a bear market in stocks, interest has been shifting from equities to alternative energy and emerging markets. Investors have become less tolerant of losses and are allocating assets to managers who have demonstrated they can thrive in turbulent markets.

Microsoft’s renewed interest in Yahoo! will alert hedge funds

Hedge funds will be drooling at the latest news on Yahoo! and Microsoft. Microsoft has declared that it is interested in reopening talks to buy all or part of Yahoo! – if a new board is appointed first.

This announcement, just about a month before the internet company’s (belated) annual shareholders’ meeting, endorses the fading efforts of activist investor Carl Icahn to unseat Yahoo!’s chief executive, Jerry Yang, and the rest of the board that failed to reach an agreement on Microsoft’s earlier takeover offer.

Microsoft says that, with a new board in place, it would be interested in discussing a deal either to assume Yahoo!’s search function "with large financial guarantees" or to buy the company outright.

The opportunities for hedge funds are manifest. Paulson & Co, the New York-based hedge fund manager, has already thrown its weight behind Icahn’s plans to challenge the Yahoo! board by putting forward an alternative slate of directors, on the grounds that the board had acted "irrationally" in refusing the software giant’s USD47.5bn bid.

In May, Paulson disclosed in a regulatory filing it had built up a stake of about 3.4 per cent of Yahoo! With the power of liquidity clearly belonging to hedge funds in the current market environment, expect more funds to join the fray.

Lesson still not learned

If ever there was a lesson to be learned from the spate of catastrophes precipitated by the credit crunch, it should be that mistakes made in the past should be remedied to prevent future problems in the market.

But yesterday’s reports have shed new light on how far the UK authorities are from having a strong handle on current market activity. New rules introduced last month that oblige UK-based hedge funds and other investors to disclose short positions in companies conducting rights issues have caused confusion, according to the Financial Times.

Almost half the disclosures made by hedge funds to the so far have contained errors. According to the FSA, 20 of the 41 disclosures missed filing deadlines, contained the wrong figures or were not even required (one firm reported a short position in a company that had not in fact launched a rights issue).

The mistakes illustrate the difficulties faced by hedge funds and other short-sellers in applying rules imposed by the FSA with just a week’s notice. The UK regulator used emergency powers for the first time to bring in without consultation regulations requiring the disclosure of short positions amounting to 0.25 per cent or more of the stock of a company going through a rights issue.

"We are aware that it is early days, but we are keeping the technicalities of the disclosures under review," the FSA says.

After all that has happened in the last year or so, the financial watchdog might have been expected to respond in a more considered manner, rather than forcing through new measures that to some observers smack of panic. The haste of their introduction, and the problems practitioners are encountering in complying, do not leave the impression of a financial market under calm, authoritative supervision.

Shorting hits India

Indian stock markets have been witnessing a bloodbath of late, and India-focused hedge funds, which earlier were pushing up the market to unprecedented heights, are now looking to benefit from the slide by going short on India, reports say.

Many are doing so by borrowing shares from foreign institutional investors and then dumping those shares in the market. So far in 2008, foreign investors have sold a net USD6.5bn worth of shares, and a sizeable portion of those sales are believed to have been made by hedge funds, according to the Economic Times.

But experts are unsure whether the recent spate of sales by hedge funds stems from redemption pressure or market strategy. With credit concerns governing investment decisions, many hedge funds now have a lower risk tolerance that is driving sentiment across the globe. This, coupled with weakness in stock markets and the economy, probably justifies the sentiment at the recent Gaim conference, where global macro and market neutral strategies were viewed as the way forward in this uncertain climate.

On that note, GLG Partners, the hedge fund manager run by Noam Gottesman and Emmanuel Roman, has hired Driss Ben-Brahim from Goldman Sachs to run its emerging markets special situation hedge fund and steer its macro trading platform. It will be interesting to see if the new recruit also goes short in the subcontinent

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