Cliffwater March 2015 Hedge Fund Market Commentary

Created with MPI StylusTMHedge Fund Market Commentary - March 2015 2015 Cliffwater LLC. All rights reserved.

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Hedge Fund Market Commentary March 2015

Broad Markets: Equities

Total Return (%)

Month QTD CYTD FYTD 1 Year 3 Years 5 Years

S&P 500 Index -1.58 0.95 0.95 7.12 12.73 16.11 14.47Russell 2000 Index 1.74 4.32 4.32 6.04 8.21 16.27 14.57Russell 3000 Index -1.02 1.80 1.80 7.15 12.37 16.43 14.71MSCI AC World Index -1.55 2.31 2.31 0.36 5.42 10.75 8.99MSCI AC Asia Pacific Index 0.46 6.72 6.72 2.18 8.60 7.60 5.81MSCI AC Europe Index -2.69 3.40 3.40 -8.87 -5.70 8.44 5.79MSCI Emerging Markets Index -1.42 2.24 2.24 -5.78 0.44 0.31 1.75

5 Year Risk StatisticsStandard

Deviation (%)EquityBeta *

CreditBeta *

12.97 0.84 0.0917.76 1.02 0.1413.46 0.86 0.1414.40 1.00 0.0014.28 0.90 -0.0119.19 1.30 -0.1418.08 1.13 0.07

Equity markets around the world saw a divergence in performance in March: US markets sold off (although small caps rallied) while Asian and European equity markets generally rallied (in local currency terms but not in USD terms).

March opened the month with a new all-time high for the S&P 500 at 2,117.39 although the index sold-off for the rest of the month, finishing down 1.6%. The Nasdaq Composite Index briefly topped 5,000 for the first time in 15 years and neared it its dot-com-era closing record, but the index finished the month down 1.2%. The big news for the Dow Jones Industrial Average this month was that Apple was added and AT&T was deleted after the close on March 29, 2015.

European equities rallied over the month on speculation the Fed will leave interest rates at zero past mid-year while European policy makers press stimulus. However, the appreciating US dollar (depreciating euro) wiped out most of those gains. Progress in negotiations between Greece and the troika of bailout overseers (the European commission, ECB and IMF) further boosted European markets.

The VIX index increased to 14.83 (with a high during the month of 17.19 and a low of 12.54) from February's 13.34, but still remains well below its 20.97 close from the end of January.

Broad Markets: Fixed Income

Total Return (%)


Barclays Aggregate Bond 0.46 1.61 1.61 3.60 5.72 3.10 4.41Barclays Government 0.61 1.60 1.60 3.83 5.22 2.32 3.80Barclays Muni Bond 0.29 1.01 1.01 3.92 6.62 4.05 5.11Barclays TIPS -0.47 1.42 1.42 -0.68 3.10 0.63 4.29Barclays High Yield Corporate Bond -0.55 2.52 2.52 -0.40 2.00 7.46 8.59BBA 3 Month LIBOR Index 0.02 0.06 0.06 0.18 0.24 0.32 0.34



CreditBeta *

2.80 -0.03 0.293.27 -0.07 0.143.87 -0.01 0.315.25 -0.03 0.796.27 0.21 0.970.05 0.00 0.01

US interest rates declined slightly in March as the US 10-year Treasury bond closed at 1.92% from last month's 1.99%. As a result, interest rate sensitive fixed income securities posted modestly positive returns for the month. However, a better-than expected employment report pushed the 10-year yields briefly to 2.25% amidst a choppy trading month and led to a sell-off in equities. The timing of the Fed's first interest-rate increase in nine years remains the main focus for market participants.

The US dollar rallied the most on a single day since 2011 on March 6 as the jobs report bolstered the case for higher rates at the same time global central banks from Japan to China and Europe embrace monetary stimulus to spur growth.

In the Fed minutes released after their two-day meeting on March 18th, the FOMC dropped the word patient, as expected, and hinted that rates would be increasing soon (although not until at least June 2015).

In the credit markets, rate and oil volatility coupled with outflows from mutual funds weighed on the market in the first half of March. Each of these factors turned more favorable as the month progressed, resulting in a partial recovery from the lows for high yield bonds, which ended the month down 55 basis points. Within high yield, CCCs had the weakest performance, while BBs and Bs fared slightly better. Leveraged loans (+48 bps) performed better, continuing to benefit from a lack of supply.


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Real Assets

Total Return (%)


Bloomberg US Commodity Index -5.14 -7.52 -7.52 -27.10 -27.04 -11.52 -5.71FTSE NAREIT US All Equity REITs 1.01 3.98 3.98 14.51 22.67 14.04 15.59Alerian MLP Index -4.24 -5.23 -5.23 -14.61 -2.51 9.20 13.67UBS Global Infra & Util 50-50 Index -2.05 0.34 0.34 -0.76 6.90 13.09 10.03



CreditBeta *

15.43 0.71 0.1015.69 0.71 1.0714.02 0.48 0.6111.88 0.78 -0.18

March saw a reversal of the strong gains made by commodities in February and the commodity index fell 5.1% on the month. Six commodities posted double-digit losses and 17 of 24 commodities finished down for the month. Thanks to continued capacity concerns and higher production, energy was the worst performing sector this month (-10.1%). Brent crude, the biggest commodity in the index, fell the most in the sector, declining 12.3% due to higher output from Libya and possibly an export boost from Iran once sanctions are lifted. Livestock was the best performing subsector with feeder cattle gaining 9.0% on the month on the back of lower-than-anticipated production.

MLPs resumed their downward trend and declined 4.2% in March, with performance largely tied to commodity prices. MLPs have declined in six of the last seven months and are down 18.2% since the end of August 2014. Despite the recent weakness, fourth quarter earnings and 2015 guidance held up reasonably well, with the exception of E&P focused MLPs which have the most direct link to the decline in crude oil. Midstream and downstream MLPs, however, have not been nearly as impacted from a fundamental standpoint as production volumes are still increasing, albeit at a lower rate than was previously projected.

US REITs returned 1.7% in March, outperforming the S&P 500 by a wide margin due to ongoing strong fundamentals as well as declining interest rates. Elsewhere, Europe (-4.4%) was weak, while Asia/Pacific (-0.5%) and Emerging Markets (-0.6%) declined slightly as well. Within the US, Apartments (+3.8%) were the best-performing sector followed by Regional Malls (+2.3%), Office (+2.3%), and Shopping Centers (+2.2%). In deal news, the Macerich Board of Directors rejected a $16 billion offer from Simon Property Group and took measures to prevent a hostile takeover. The proposed transaction, which valued Macerich's portfolio at an implied cap rate of 4.2%, would have combined the #1 and #3 US shopping mall owners.

Hedge Funds: Overview

Total Return (%)


HFRI Fund Weighted Index ** 0.53 2.43 2.43 2.25 4.30 5.36 4.55HFRI FOF: Composite Index ** 0.57 2.50 2.50 3.77 5.36 5.38 3.52



CreditBeta *

5.13 0.28 0.274.02 0.19 0.25

Hedge funds posted solid returns in March with the HFRI Fund Weighted and Fund of Funds Composite indices returning 0.5% and 0.6%, respectively.

According to Morgan Stanley, first quarter median hedge fund returns have outpaced both the S&P 500 and the MSCI AC World for the first time in six years.

Following in February's footsteps, hedge fund strategies across the board produced positive returns in March. Performance was led by macro (0.7%), particularly systematic strategies that capitalized on trends in the US dollar and short oil.

Despite a weak equity markets, equity long/short funds still managed to post positive returns. This is attributable to strong manger alpha generation and ability to protect capital during the March market sell-off.


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Hedge Funds: Market Neutral/Arbitrage

Total Return (%)


HFRI Relative Value Index ** 0.25 1.67 1.67 0.91 3.35 6.34 6.14HFRI Convertible Arbitrage Index ** 0.23 2.13 2.13 0.25 1.41 4.61 4.90



CreditBeta *

3.04 0.10 0.464.56 0.17 0.46

Fixed income arbitrage managers generated profits in March as volatility remained elevated at the front-end of the US Treasury yield curve. Fixed income relative value managers remained focused on classic relative value opportunities such as bond-basis trades. In particular, 2-year Treasury futures were trading cheap to cash bonds but long-end futures were trading rich to cash throughout the month of March. Fixed income arbitrage managers were increasingly cautious in Europe, as there was limited liquidity in the repo market for German bunds (due largely to ECB asset purchases).

Convertible arbitrage managers generated modest profits in March. Convertible bonds held up well during a weak month for US large cap equities and the new issue market was relatively more subdued. The long-only BofA Merrill Lynch All Convertibles Index returned 0.2% in March but convertible arbitrage funds outperformed because of their focus on lower-quality, high yield or unrated issues, while the index is dominated by large, investment-grade bonds. While not as robust as February, the new issue market raised $3.1 billion in the US across 7 deals. Convertible arbitrage managers expect new issuance activity to remain robust as companies increasingly utilize convertible bonds to finance M&A transactions, raise money ahead of interest rate hikes, and as energy companies seek to improve their balance sheets. The primary calendar in Europe also picked up notably in March, while activity in Asia continued to be focused on Japan, particularly on the financial sector.

Volatility arbitrage managers with a long volatility bias generated small gains in March as implied equity and fixed income volatilities increased somewhat. Long volatility managers are optimistic that the increasing divergence in central bank policy will result in a more favorable environment with a sustained level of higher fixed income and equity market volatility in 2015.

Hedge Funds: Credit/Distressed

Total Return (%)


HFRI Corporate Index ** 0.34 1.59 1.59 -1.73 0.76 4.95 5.38HFRI Distressed/Restructuring Index ** 0.25 0.61 0.61 -5.95 -3.57 5.93 5.48



CreditBeta *

3.74 0.10 0.655.25 0.20 0.48

Credit markets posted losses during March, with lower quality sectors having the weakest performance. Within high yield, CCCs underperformed (-1.0%), while BBs (-0.5%) and Bs (-0.6%) fared slightly better.

Leveraged loans (+0.5%) performed better, continuing to benefit from a lack of supply. The worst performing sectors were Metals & Mining (-2.8%) and Energy (-2.4%) while Food/Beverages (+1.3%) and

Housing (+0.6%) were the best performers Credit Hedge funds generally performed in-line or slightly better than the broader credit markets, with returns ranging

from down 50 basis points to up 1%. Many funds benefited from the successful auction for Indiana Toll Roads, which resulted in a purchase price in the

mid-90s, exceeding many funds' expectations and resulting in over a 10% gain on the position.


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Hedge Funds: Event-Driven

Total Return (%)


HFRI Event-Driven Index ** 0.58 2.01 2.01 -1.16 1.12 6.41 5.50HFRI Activist Index ** -0.46 2.79 2.79 6.40 8.81 12.62 8.66



CreditBeta *

5.18 0.23 0.3611.73 0.52 0.11

Rising levels of corporate activity contended with choppy markets leading to a mixed but generally positive March for event driven strategies. As small cap stocks significantly outperformed large cap ones in March this boosted the returns of many special situations portfolios. Activist managers retraced some of the prior month's gains with an average loss of 0.5%.

A number of high profile event driven situations were resolved in March. Most notably, the Actavis/Allergan deal, which was a widely held merger arbitrage position, closed earlier than expected. GM reached an agreement with a group of hedge funds on changes to its capital allocation plans, and Yahoo! continued to take incremental steps towards satisfying the demands on an activist investor by increasing its stock buyback. On the credit side, the Indiana Toll Road auction achieved a better than expected resolution with creditors, including many hedge funds, recovering 95 cents on the dollar (after the debt traded as low as 60 cents last year).

Global M&A volume rose 21% year-over-year in the first quarter and registered the best start to a year since 2007. In the US, M&A rose 6% year-over-year and was once again skewed to larger deals; 43% of the announced deals had a value in excess of $5 billion compared to the historical average since 1998 of 17%. While the size distribution and sector leadership (healthcare) remain skewed, the first quarter did produce a broadening of M&A activity compared to last year. This has all translated into increased merger arbitrage exposure across event driven portfolios to the highest levels since before the financial crisis.

Hedge Funds: Equity Long/Short

Total Return (%)


HFRI Equity Hedge Index ** 0.51 2.34 2.34 0.90 3.04 6.16 4.72HFRI Equity Market Neutral Index ** 0.70 1.67 1.67 3.07 3.54 4.15 2.78



CreditBeta *

7.52 0.44 0.242.62 0.11 0.12

In March, equity markets pulled back following outsized gains in the prior month, and finished the quarter on a weak note. Similar to the prior month, there was not much dispersion in terms of geographic or factor returns. Most sectors declined, with outsized losses in higher beta sub-sectors including information technology and energy which continued to decline along with oil prices. Healthcare notably bucked the downward trend, and rallied due to positive fundamental newsflow and industry consolidation.

Equity long/short managers as a whole generated positive returns for the month, despite the market losses. Managers continued to generate strong outperformance in their long portfolios. Many managers also exhibited positive alpha in their short portfolios, led by positions in commodity related companies which declined sharply.

The dispersion of manager returns was low relative to recent history. Outliers on the upside were led by managers with outsized long exposure to healthcare companies, while outliers on the downside were led by managers with outsized long exposure to semiconductor companies which declined sharply on the month, including Micron which is a widely held position that lost 11.5% following weaker than expected forward guidance.

In response to recent declines to forward earnings estimates, equity long/short managers have been reducing net exposure.


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Hedge Funds: Global Macro

Total Return (%)


HFRI Macro Index ** 0.70 3.39 3.39 8.05 9.49 2.53 2.43HFRI Macro: Discretionary Index ** 0.40 1.75 1.75 -0.62 0.33 0.36 0.46HFRI Macro: Systematic Index ** 1.06 5.13 5.13 16.19 18.26 4.19 3.61



CreditBeta *

4.42 0.13 0.164.30 0.23 0.197.25 0.11 0.07

Global macro funds were the best performing hedge fund strategy in March, continuing 2014's trend. The negative correlation property of the global macro strategy was evident in March as equities sold off while global macro funds, both discretionary and systematic, were strongly in the black. A rally in fixed income and the US dollar benefitted most managers.

CTAs profited in March from gains in major currency markets, mainly short the euro and the British pound. Long fixed income and short oil trades, which have been driving performance for the past two quarters, continued to add value to CTA portfolios.

Discretionary macro managers profited from the continued strengthening of the US dollar. By mid-March, DXY (the US dollar Index) reached 100, a level not seen since 2003, although the index retreated by the end of the month. Specifically, the US dollar surged to a 12-year high versus the euro and the highest in 7 1/2 years against the yen, both of which led to gains in discretionary portfolios. DXY ended the month up 3.2%, marking its 9th consecutive month of appreciation.

Most discretionary global macro traders continue to be preoccupied with the timing of the Fed's interest rate hikes. It now seems much less likely that the Fed will raise interest rates in June 2015, which had been a consensus date for most managers early in the year. Now, most managers think the hike will occur later in the year, in September, October or even December 2015.

Hedge Funds: Multi-Strategy

Total Return (%)


HFRI RV: Multi-Strategy Index ** 0.46 1.97 1.97 2.15 3.97 5.94 5.22



CreditBeta *

3.05 0.11 0.33

Multi-strategy funds generated gains in March as performance ranged from -0.5% to +1.5%. Within their equity long/short portfolios, multi-strategy funds demonstrated good stock selection in both the US and

Asia and also benefited from the successful closings of two widely-held M&A deals, Allergan/Actavis and Salix/Valeant. Managers remained optimistic about M&A activity in 2015 and expected both strategic and financial buyers to continue to pursue large, complex, multi-national transactions.

US and European structured credit markets were firm in March, holding up better than equity and high yield bond markets. Some multi-strategy managers took profits on paper that had experienced spread compression ahead of the ECB's asset purchases, which began with sovereign debt in March. Multi-strategy managers also benefited from the continued liquidation/reorganization of legacy multi-sector CDOs.


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Other Hedge Fund News

Operations: Hedge fund managers are continuing to have active dialogue with their current prime brokerage relationships assessing

the impact of the Basel III. Several prime brokers have increased financing rates while others have started to implement financing terms based on the credit quality of the fund's assets. Hedge funds that do not generate significant revenues for the banks, typically in the form of utilizing leverage or shorting cash securities, are moving to reduce the number of prime broker relationships and increase the usage of custodians. Hedge funds have also started to utilize portfolio finance software models to optimize fees paid to prime brokers.

New legislation is expected to be introduced to explicitly define rules for insider trading and prosecutions of insider trading cases. This follows the recent court ruling that overturned the insider trading convictions of two separate hedge fund traders.

Daniel [email protected]

April 10, 2015

* "Equity Beta" and "Credit Beta" represent the beta coefficients of the MSCI ACWI and Barclays US High Yield Loans indices, respectively, which were calculated via two-factor unconstrained ordinary least squares regression using monthly returns over the trailing 5 year period.

** Hedge Fund Research, Inc. ("HFR") is the source and owner of the HFR index data contained in this report and all trademarks related thereto.

The views and information herein reflect the views of Cliffwater and information only through the date hereof and are subject to change without notice. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. Cliffwater has not conducted an independent verification of the information. No representation, warranty, or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained in this report. This report is not an advertisement and is not intended for distribution, commercial use or for the investing public. Rather, this report is being distributed for informational purposes only, should not be considered investment advice, and should not be construed as an offer or solicitation of an offer for the purchase or sale of any security. Any ratings do not create an investment adviser client relationship. Cliffwater shall not be responsible for investment decisions, damages, or other losses resulting from the use of the information. Past performance does not guarantee future performance.

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Cliffwater March 2015 Hedge Fund Market Commentary