The Morningstar 1000 Hedge Fund Index gained only 0.1 per cent in December, but ended the year up 19.5 per cent, missing 2003’s 20.3 per cent rise by a small margin.
Similarly, the currency-hedged Morningstar MSCI Hedge Fund Index rose just 0.2 per cent in December, but finished the year up 14.1 per cent.
The second and third quarters of 2009 generated the most profit for hedge funds, as the global recovery in stocks and bonds waned toward year end.
The Morningstar 1000 Hedge Fund Index and the Morningstar MSCI Hedge Fund Index rose 2.1 per cent and 1.9 per cent, respectively, in the fourth quarter, while the MSCI World Stock Index gained 4.1 per cent and the BarCap Global Aggregate Bond Index declined 0.9 per cent over the same period.
“2009 was a windfall year for hedge funds,” says Nadia Papagiannis, alternative investment strategist at Morningstar. “The hedge funds that survived 2008`s industry purge, or those that launched in the aftermath, picked up assets at rock-bottom prices and rode the recovery to near record profits, particularly in US equity and debt markets.”
The least successful strategies of 2008 became the most profitable in 2009. The Morningstar Emerging Market Equity Hedge Fund Index took the largest hit in 2008, declining 45.7 per cent, but rose 50.4 per cent in 2009.
The currency-hedged Morningstar MSCI Emerging Markets Hedge Fund Index increased 1.7 per cent in December, and 37.1 per cent for the year.
The Morningstar US Small Cap Equity Hedge Fund Index finished as the second-worse performing strategy in 2008, dropping 32.8 per cent, but the third best in 2009, rising 36.4 per cent.
These hedged-equity strategies suffered from poor liquidity in 2008, but regained strength as liquidity returned to the markets in 2009. However, the average emerging market or small-cap equity hedge fund has not yet recovered from 2008’s losses.
Convertible arbitrage was among 2008’s worst-performing strategies, but it was 2009’s second-best strategy. The Morningstar Convertible Arbitrage Hedge Fund Index rose 2.1 per cent in December, and more than 37 per cent in 2009, as many convertible-arbitrage hedge funds were wiped out in 2008, leaving opportunity for those that remained in the market.
Merger arbitrage strategies saw a similar fallout in 2008, as broken merger deals and investor redemptions caused the liquidation of many of these hedge funds. In 2009, however, merger activity picked up slowly, and reduced competition in merger-arbitrage trades allowed for outsized profits. The Morningstar Corporate Actions Hedge Fund Index, which includes merger arbitrage hedge funds, rose 0.3 per cent in December and 30.0 per cent for the year.
Some hedge fund strategies, though, experienced unimpressive returns in 2009. The Morningstar Short Equity Hedge Fund Index and the Morningstar Global Trend Hedge Fund Index each fell 3.1 per cent in December, ending the year down 1.4 per cent and 1.5 per cent, respectively.
Substantial rebounds in the global equity markets hurt those hedge funds that take bets on declining stocks. Global Trend hedge funds, which profit from momentum or price trends in currencies, interest rates, stocks, and commodities, were challenged when price trends reversed in many of these markets throughout the year. Ironically, these same strategies were the only two that protected wealth in 2008.
Although outflows from hedge funds in Morningstar’s database netted USD53.4bn for the year through November, positive inflows started in June as redemption gates lifted and market conditions improved. Most recently, hedge funds enjoyed USD4.7bn of inflows in November 2009, led by Europe equity, US equity, multi-strategy, and global non-trend hedge funds, which bet on macro-economic themes.
Other notable trends for the year include the outperformance of small hedge funds over large and single-manager hedge funds over funds of hedge funds. The Morningstar MSCI Composite Small Fund Hedge Fund Index jumped 21.5 per cent in 2009, while the Morningstar MSCI Composite Core Fund Hedge Fund Index increased only 16.5 per cent. Funds with smaller assets under management can more easily take advantage of riskier, smaller, and less-liquid investment opportunities.
The Morningstar Hedge Fund of Fund Index underperformed single-manager multi-strategy hedge funds (as measured by the Morningstar Multi-Strategy Hedge Fund Index) in 2009 by a wide margin of more than nine percentage points. Hedge funds of funds came under fierce criticism after poor performance and scandal in 2008, and 2009’s results did not help to bolster their market share.
