Hedge funds in Morningstar's database returned an average of 2.44 per cent over the third quarter of this year, outperforming the S&P 500 and MSCI World indices in US dollar terms after September gains of 3.7 per cent overcame poor performance in July, when hedge funds averaged a meagre gain of 0.42 per cent, followed by a 1.63 per cent decline in August.

Another strong quarter in developing markets paved the way for emerging-markets hedge funds to earn 7.48 per cent (in US dollar terms). Considering that the MSCI Emerging Markets Index returned 13.7 per cent, however, hedge funds failed to participate fully in the sector's surge. Much of the gains came in September, when the index hit an all-time high.

Global macro funds earned a respectable 3.57 per cent. Funds that bet against the dollar benefited from its record low against several currencies, most notably the euro, in September.

Commodities (wheat, oil, and gold) recorded record monthly gains in September, which helped managed futures hedge funds offset losses from a volatile July and August to gain 2.22 per cent over the quarter.

Global merger and acquisition dollar volume dropped in the third quarter of the year, according to investment banking information provider Dealogic, as credit markets that had been used to fund deals tightened. Spreads on announced deals widened, making it a risky quarter for merger arbitrage funds, which lost 0.07 per cent, while corporate event-driven funds posted a 1.6 per cent decline.

Widening spreads also hurt convertible arbitrage funds, with their long convertible bond exposure, which earned only 1.21 per cent for the quarter. Fixed-income arbitrage funds fared better at 3.04 per cent, but distressed funds suffered substantially during the market turmoil, losing 2.86 per cent.

High volatility proved a boon for equity net neutral funds trading equity volatility with options, which returned 3.03 per cent over the quarter, while equity variable funds that have net short exposure to the market at times also prospered with a 3.13 per cent return.

However, stock market volatility hit equity net long funds hard in August, allowing only a 1.46 per cent return for the quarter, while multi-strategy funds matched the return of funds of hedge funds at 1.55 per cent.

'Overall, September gains led to positive third-quarter results,' says Morningstar hedge fund analyst Nadia Van Dalen. 'Emerging markets and global macro funds prospered, while distressed and event-driven funds struggled.'

Morningstar has around 7,500 hedge funds and funds of hedge funds in its database, grouped into 15 categories. Quarterly performance is based on data from funds that reported returns to Morningstar as of this month.


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