Anecdotally, July seems to have been one of the worst hedge fund months in a long time. As spreads on High Yield bonds jumped about 150 basis points, it appears that this factor is very important in explaining hedge fund returns. You see, 150 basis points on 10 year bond will cost you about 10% in principal. Ouch. Macquarie's Fortress Investments gave $188mm to a US manager, which then levered it 5 times, and the WSJ reports they may have lost 20-25% in July. Sowood Capital Management's $3B fund lost 50% in recent months, including $350mm of Harvard's money (Citadel is buying Sowood's positions). Bear Stearns announced it is suspending redemptions in one of its asset backed funds that has no home equity exposure: the general increase in spreads hurt these funds too. Lastly, American Home Mortgage is finding its business model strained by this mess, and the stock fell 90% yesterday (see AHM).

Since the fall of 2002, investing in high yield securities has been a no-brainer. After a couple years making big bucks levering up in these securities, risk managers who might have questioned the strategy were probably moved into 'risk methodology' or special projects. Its just too hard to argue with someone making abnormal for 5 years straight, you have no credibility as a skeptic after only a couple years. But High Yield debt markets are a poor place to try to ply your alpha. There just isn't enough liquidity, enough variance, to do anything but take a dumb leveraged bet on the sector, and historically the High Yield indices have not returned much above the investment grade indices, meaning, eventually, you give back all you make in those fat years.