Hedge funds see biggest returns since 2007

Convertible bonds have produced some of the most remarkable hedge fund gains this year after savage deleveraging in the asset class in 2008, according to industry research.

The Edhec-Risk Institute and Morningstar both flagged up massive returns in convertible arbitrage strategies as participants entered the market at record valuations, with Edhec's Convertible Arbitrage strategy topping levels reached in October 2007.

Overall, the strategy has returned 43.8 per cent over 10 months, while Morningstar's Convertible Arbitrage Hedge Fund index gained 32.1 per cent for the year to September.

According to Morningstar, "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".

Elsewhere in the bond world, Edhec said its Distressed Securities and Fixed Income strategies also performed well last month, returning 4.4 per cent and 2.7 per cent, respectively. The Morningstar Distressed Hedge fund index rose 6.7 per cent.

Equity strategies also continued their recent gains. The Morningstar MSCI Emerging Markets Hedge Fund index went up 4.6 per cent in September, making 31 per cent over the year as Bric markets rallied. By contrast, the Morningstar Global Equity Hedge Fund index went up 3.7 per cent, slightly less than the 4 per cent for the MSCI World Equity index.

Edhec's indices posted smaller but nevertheless positive gains. Equity Market Neutral edged up 0.8 per cent, while Event-Driven rose 3.6 per cent and Long/Short Equity 3 per cent. The appreciations were closely correlated with the S&P 500, which went up 3.7 per cent.

Nadia Papagiannis, Morningstar alternative investments strategist, went as far as to say hedge funds had started to "regain their swagger" in the third quarter after only one Morningstar strategy, Short Equity, failed to post gains.

She said: "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."

Overall, hedge funds have not yet hit the highs of October 2007. The Morningstar 1000 Hedge Fund index went down 25.2 per cent through February and has risen only 20 per cent since.

Investors have rushed back into the asset class in the very recent past, with $5.9bn (£3.5bn) entering funds in Morningstar's database in August.

However, most held back over the year overall, with outflows coming to $59.7bn.