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On June 22, 2010 with 3,466 hedge fund products reporting performance, the HFN Hedge Fund Aggregate Index was -2.86% in May 2010 and +0.89% year-to-date (YTD). The S&P 500 Total Return Index (S&P) was -7.99% in May and -1.51% YTD.

Hedge Fund Industry Highlights:
• Total industry assets fell an estimated -2.82% to $2.234 trillion in May. Despite performance based asset reductions, net investor flows were positive for the fifth month in a row.
• Long-biased equity strategies and emerging markets suffered most during the month. Short-biased funds were the only primary strategy to post positive returns.
• The HFN Hedge Fund Aggregate Index ended May needing to rise +2.94% to regain a peak level, an indication that many funds may have entered a period of weak fee generation.
• Equity sector focused funds continued to experience net outflows with funds investing in the healthcare sector being the lone exception.

May performance was a sharp reversal from April and was highly influenced by falling equity markets. Global equity market declines were highlighted by the “flash crash” early in the month, however indices had already begun a steady fall at the start of the month and ended lower.

Hedge fund performance relative to equity markets was significantly positive. While it is likely the benchmarks will drift lower as more funds report, the differential between long/short equity strategies and the S&P will likely remain the largest in fourteen months. This is a very good indication that many managers have been positioned cautiously. Long-only funds were significantly more adversely affected. Fixed income strategies performed better than equity or commodity strategies, but were still -0.90% on average. Returns were supported by mortgage sector funds.

Regional Overview
Emerging market equity strategies were the largest drag on regional returns in May, though all HFN regional/country specific benchmarks significantly outperformed the S&P 1200 Global during the month.

Funds investing in the MENA region produced the worst aggregate performance, likely influenced by the 22% intra-month drop in oil prices. This price decline was a large factor in Russia’s equity market declines. Russia’s primary equity market benchmark, the RTS$ Index, fell more than 11% in May and is down more than 4% YTD, yet the HFN Russia Index was -6.85% in May, but still +4.05% in 2010.

Emerging market debt focused strategies faired much better during the month. Funds investing in Brazilian bonds showed the most resiliency, falling only -0.56% in May. Latin American debt strategies outside of Brazil had a more difficult month, but continue to be strongly influenced by volatile returns from funds investing in distressed Argentine debt markets. Eastern European bond strategies performed significantly better than their equity market peers, but were -3.72% on average.

Funds investing in Japanese markets had been a highlight of the regional concentrations in 2010. Prior to May, many of these funds were en route to their best year since 2003 when the HFN Japan Index was +20.44%; the last time the benchmark produced double digit returns.

Monthly Asset Flow Estimates
• Total estimated hedge fund assets at the end of May 2010 were $2.234 trillion, decrease of 2.82%, or $64.74 billion from April.
• Performance accounted for $66.87 billion of the decrease and investor allocations accounted for a net inflow of $2.13 billion. Net inflows were the lowest since January, the second month in a row of slower rates of increase.
• The core rate of growth (% asset change due to investor allocations/redemptions) was an increase of 0.09%, the second slowest rate of increase since HFN began tracking asset flow data in Q4 2003.
• Through May 2010, investors have added a net $26.46 billion to the hedge fund industry while performance has added an additional $36.04 billion.

The optimistic aspect of the flow data from May is that despite performance losses, investor flows were positive. Additionally, the last time the industry experienced a month of average performance declines, January 2010, it was not followed by a wave of outflows. However, the declining rate of flows since February, along with the recent losses will make June data an important litmus test of the conviction of hedge fund investors.

May Sub-Sector Specific Flows
• U.S. based funds had above average net inflows in May while funds investing in Europe experienced their first net outflows in five months.
• Funds investing in Europe and Eastern Europe were responsible for all net outflows on a regional investment basis in May. This is not a surprise given the heightened un-certainty around many euro-zone economies.
• Equity strategies experienced a slight net outflow in May following three straight months of inflows. Fixed income strategy assets increased more than 1% due to net investor flows, the highest rate in six months.
• Relative value strategies (macro, arbitrage, event driven) were the primary receivers of net positive investor inflows in May. Long/short, distressed and even CTA/managed futures products had net outflows.

May Performance Review
Fixed Income (FI) Strategies
• The average of all fixed income focused strategies was -0.90% in May and +4.60% YTD.
• High yield strategies fell most, -2.18% and mortgage strategies were only down slightly, -0.09%.
• Fixed income fund assets fell an estimated -0.20% to $534.49 billion. Investors added net $6.06 billion in May.

Equity (EQ) Strategies
• The average of all equity focused strategies was -3.55% in May and +0.65% YTD.
• EQ natural resource sector focused funds fell most, -5.48%, but all sector focused strategies were down for the month.
• Equity fund assets fell an estimated -5.15% to $712.56 billion. Investors withdrew net $5.47 billion in May.

Commodity and Foreign Exchange (FX) Related Strategies
• Broad natural resource commodity strategies were -2.30% in May and -2.24% in 2010.
• Oil/energy related commodity funds fell most in May, -4.08%, but agriculture and metals strategies dropped as well.
• FX strategies were again mostly positive, +0.30% and the group is +3.00% YTD.

Summary Analysis
Global developed equity markets are near flat for June, but some EM countries are showing gains following large losses in May. A fair amount of uncertainty remains on the global economic front and U.S. treasury yields have fallen significantly during the month reaching levels not seen in over a year. Major commodity prices appear to be the beneficiaries of this environment and gold has risen nearly 3% in June at the time of writing. With fund inflows slowing for the third month in a row, should the industry have another difficult month we may begin to see net outflows for the first time since December.

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