The Morningstar 1000 Hedge Fund Index climbed 7.4 per cent during the third quarter of 2009 and 17.2 per cent through the first nine months of the year.
The currency-hedged Morningstar MSCI Hedge Fund Composite rose 6.1 per cent for the quarter and 12.1 per cent for the year through September.
"Paced by an exceptionally strong September, hedge funds began to regain their swagger in the third quarter," says Nadia Papagiannis, Morningstar alternative investments strategist. "The road to recovery for hedge funds was paved by strong performance in riskier asset classes such as emerging markets, distressed, and small-cap securities."
But hedge funds overall have not yet returned to their October 2007 peaks: the Morningstar 1000 Hedge Fund Index declined 25.2 per cent through February 2009, and has only recovered 20 per cent in the last seven months, with 11.4 per cent to go.
Certain hedge fund strategies have set new highs, however. In September, the Morningstar Global Non-Trend Hedge Fund Index, which includes hedge funds following global macro-economic strategies, fully recovered from 2008 losses, despite lagging the performance of other category indexes this year. Appreciation of the Australian dollar and the Euro versus the US dollar as well as spikes in silver and gold prices helped this index rise 1.9 per cent in September.
Convertible arbitrage and emerging markets hedge funds have outperformed all other Morningstar categories thus far in 2009. The Morningstar Convertible Arbitrage Hedge Fund Index rose 3.0 per cent in September and 32.1 per cent for the year through September, while the currency-hedged Morningstar MSCI Emerging Markets Hedge Fund Index increased 4.6 per cent in September and 31.0 per cent for the year through September.
Convertible bonds, which crashed in 2008 due to forced selling by leveraged hedge funds, are enjoying a tremendous 2009. Low prices and higher yields attracted traditional, non-hedge-fund investors, while more companies issued convertible bonds during tight bank lending conditions and rapidly rising equity prices. Emerging markets hedge funds benefited from outsized rallies in Indian, Russian, and Latin American stocks in 2009.
Strong equity markets in developed countries buoyed funds in the Morningstar Global Equity Hedge Fund Index, which increased 3.7 per cent in September – slightly less than the MSCI World Equity Index, which rose 4.0 per cent. The Morningstar MSCI Developed Markets Hedge Fund Index rose only 2.5 per cent, however, as allocations to Japanese stocks dragged down performance. The Morningstar MSCI Japan Hedge Fund Index and the Morningstar Short Equity Hedge Fund Index were the worst-performing Morningstar hedge fund indexes in September dropping 1.2 per cent and 1.6 per cent, respectively.
September saw a continuation of the rally in small-capitalization stocks, as investors snapped up riskier assets. The Morningstar US Small Cap Equity Hedge Fund Index rose 5.0 per cent and the Morningstar Distressed Hedge Fund Index, which also reflects risk appetite, jumped 6.7 per cent.
As risk-aversion declined, hedge funds once again experienced inflows. Funds in Morningstar’s database saw USD5.9bn of new flows in August, with the bulk of those assets going to global trend hedge funds. With the exceptions of August and June, investors have withdrawn assets from hedge funds every other month this year. Outflows totalled USD59.7bn for the year through August.