Hedge Fund Monitor for 1-May-06

Hedge fund returns up strongly this week

o Hedge funds returns recovered strongly for the week. The Div Hedge Fund
Index was up 0.52% last week (4.77% YTD) with 8 of 9 strategies posting
positive returns.

o European hedge funds had a solid March. The EuroHedge Index was up 1.40%
in March (4.80% YTD) as all strategies posted positive returns.

Bullish readings on equities, metals and energy

o Notable Large Speculator positions in the futures markets:

Equity Index Futures: HFs sold equity futures across the board in the S&P 500,
NASDAQ 100 and Russell 2000 but action was relatively light. The heaviest
action was in the Russell 2000 as they sold their net long positions down to
flat. Equities have more room to rally as the small cap leadership held the
uptrend line but no longer face the headwind of a Large Speculator crowded
long.

Metals: Readings look bullish for the metals. Large Speculators net long
positions in gold were steady but not excessive and silver positions look
washed out. Large Speculators are still not in copper as it rallied again to
new highs.

Energy: Large Specs bought energy across the board as Oil continued to rally.
Buying momentum with relatively neutral readings can take the energy complex
higher.

Forex: Large Speculators sold US$ and bought Euros and Yen as the Euro and Yen
rallied through important resistance. We expect further US$ weakness.

Interest Rates: HFs sold interest rate instruments across the curve. They
remain extremely short T-Bonds and sold their crowded long 10-year T-Note down
to net flat. Bonds are very oversold and could rally at any time.

o U.S. equity market neutral funds continue to have positive market betas
with other exposures unchanged. Other tilts: Value, Small Cap, Low Quality and
Inflation.

o U.S. long-short equity funds market exposure is steady at average levels.
Other tilts: Value, Small Cap, Low Quality and Inflation.

Equity Market Neutral Exposure Analysis

Significant Estimated Factor Exposures for Equity Market Neutral Funds:

o Market exposure positive

o Value, Inflationary Expectation and Low Quality tilts

Significant Factor Exposure Changes since Last Week

o Small cap exposure now only very slight and being neutralized

Long-Short Equity Exposure Analysis

Estimated Factor Exposures for Long-Short Equity Funds:

o Market exposure average

o Value, Small Cap, Low Quality and Inflation

No Significant Factor Exposure Changes from Last Week

Long-Short equity funds have historically been net long the market, and
therefore, we have calibrated their returns to their average market exposure to
better measure the factor exposures.

Hedge Fund Factor Exposure Analysis

To approximate the exposure of a hedge fund composite to a factor, we calculate
the daily returns of the composite when the factor is positive and negative and
then compare the annualized returns under the two conditions.

As an example, the interpretation of the exposure of the Equity Market Neutral
Hedge Composite to the Market Direction factor is shown in the table below. We
calculate the annualized daily returns for one, three, and 12 months of the
average fund return on days when the S&P 500 is up and when the S&P 500 is
down. We then compare the spread between the two conditions as an indication
of the exposure to that factor.

Factor Definitions

Market direction is defined as the returns of the S&P 500 Index. When the S&P
500 is up for that day, the market is up and when the S&P 500 is down for that
day, the market is down.

Style is defined as the daily return spread between the Russell 1000 Value
Index and Russell 1000 Growth Index. When the spread is positive, the style is
said to be Value and when the spread is negative, the style is said to be
Growth.

Size is defined as the daily return spread between the S&P 500 Index and the
S&P 600 Small Cap Index. When the spread is positive, the market is said to
favor Large Cap and when the spread is negative, the market is said to favor
Small Cap.

Quality is defined as the daily return spread between the S&P 500 Index and the
Philadelphia Semiconductors Index. When the spread is positive, the market is
said to favor High Quality and when the spread is negative, the market is said
to favor Low Quality. This proxy for Quality/y does not fully reflect the
returns to the Quality factor as measured by ML Quantitative Strategy. The
quality spreads, as published by ML Quantitative Strategy Team, are available
only on a monthly basis. Instead, we use the return spread between the S&P 500
and the Philadelphia Semiconductors Index, which has a monthly correlation
coefficient of 0.70 with the A+ versus C&D Quality Spread for the period June
1994- September 2004.

Inflationary expectations is defined as the daily return spread between the
Philadelphia Gold & Silver Index and the S&P 500 Bank Index. When the spread
is positive, the market is said to favor inflation and when the spread is
negative, the market is said to favor disinflation.

Long-Short Equity Hedge Fund Exposure Analysis

Long-short equity hedge funds have a historical bias of being net long the
equity market. If we measure the simple factor exposure of the long/short
equity fund indices in the same way we measure the equity market neutral hedge
composite, the long market exposure effect would overwhelm all the other factor
exposures and could result in false readings. We opted to calibrate the
returns of the long-short equity fund indices to neutralize for their market
exposure to better measure their exposure to other factors.

Limitations of Hedge Fund Exposure Analysis

o Hedge fund indices may not be fully representative of hedge fund returns.
Not all hedge funds are in hedge fund indices. The number of funds in each
strategy sub-index is relatively small. Some reasons for this non-inclusion
are funds closed to investors that do not report their performance to public
databases, funds with poor returns that stop reporting performance, and
successfully incubated funds that enter databases with "instant" track records
with a very low level of historical assets.

o Most of the hedge fund indices are approximately equal weighted. An equal-
weight index has an equal weight for each of the components in the index.
Although such a weighting methodology may better measure the broad returns of
the strategy, it may not fully reflect the strategy's investable returns
because of size differential. For example, a $200 million fund will have the
same weight in an equal-weighted index as a $2 billion fund. Assuming that
they both invest in the same universe of securities, the $2 billion fund will
naturally have a greater market impact than the $200 million fund.

o This analytical technique measures the direction of exposure but not
magnitude. Scaling the level of exposure is problematic, as the level of
volatility varies from fund to fund.

o Some hedge fund strategies are inappropriate for this type of analysis.
An example would be statistical arbitrage, where the typical holding period is
less than a week. Such a strategy is not amenable to this form of analysis as
the strategy investment horizon is shorter than the analysis look-back
periods.