Morningstar 100 Hedge Fund Index up 4.0% in December

Date: Thursday, January 27, 2011
Author: Wendy Chothia, HedgeWeek

The Morningstar 1000 Hedge Fund Index rose 4.0% in December, resulting in an increase of 10.4% for the year, according to preliminary results released by the investment research firm.

The currency-hedged Morningstar MSCI Hedge Fund Index experienced a 3.0% December boost and concluded the year up 10.6%. A year-end rally in both stocks and bonds buoyed the indexes, which have each recovered from their October 2007 through February 2009 declines.

"Hedge funds finished strongly in 2010, and most have now fully recuperated from 2008's hangover," says Nadia Papagiannis, alternative investment strategist for Morningstar.

Distressed securities and corporate event-driven strategies emerged as winners in 2010. These funds attempt to take advantage of bankruptcies and restructurings, and 2010 offered many such investment opportunities, including GM stock, Tribune bonds, and structured credit.

The Morningstar Distressed Securities Hedge Fund Index rose 3.5% in December and 24.5% for 2010, on par with 2009's outsized results. The Morningstar Corporate Actions Hedge Fund Index grew 4.6% in December and 19.4% for the year, a handsome increase but significantly less than its 29.9% rise in 2009.

Merger arbitrage, one subset of corporate actions strategies, was not as successful in 2010 as spreads (premiums paid for target companies) narrowed. The Morningstar MSCI Merger Arbitrage Hedge Fund Index rose 0.2% in December and 5.2% for the year, compared with a 12.5% increase in 2009.

Trend-following, or momentum, strategies saw the largest gains in December. A number of commodity futures, such as copper, cotton, and coffee, saw sharp upward trajectories during the month, while short positions in the five-year and 10-year Treasury futures contracts proved profitable for some hedge funds. Although trend-following hedge funds also trade equity index futures and currency forwards, positions in commodity and bond futures contracts drove returns throughout the year. The Morningstar Global Trend Hedge Fund Index jumped 7.4% in December, bolstering the year's 12.3% rise.

Equity strategies, particularly those focusing on developed Asia and emerging market stocks, managed double-digit returns in 2010, but the average hedge fund failed to outperform the broad market indexes as hedging activities reduced their returns. The Morningstar Developed Asia Equity Hedge Fund Index climbed 14.6% but fell short of the MSCI AC Asia NR Stock Index's 17.6% rise in 2010. The Morningstar MSCI Emerging Markets Hedge Fund Index increased 14.2%, but also failed to match the MSCI Emerging Markets NR Equity Index's 18.9% climb. Similarly, the Morningstar U.S. Equity Hedge Fund Index’s 13.4% rise in 2010 was short of the S&P 500's 15.1% increase for the year.

US equity hedge funds in Morningstar's database experienced net inflows of USD1.5 billion through November 2010, in contrast to outflows of USD8 billion through November 2009. Other than US equity, the only other hedge fund categories experiencing significant inflows through November 2010 were global non-trend (hedge funds that bet on macro-economic events) and corporate actions.

These categories saw net inflows of USD5.4 billion and USD1.6 billion, respectively, through November. Hedge funds falling into Morningstar's global debt and global equity hedge fund categories leaked the most assets, USD1.7 billion and USD1.0 billion, respectively, in the first 11 months of the year. Overall, however, hedge funds in Morningstar's database received net inflows of USD2.7 billion through November, the fourth consecutive month of inflows exceeding outflows.  

Although single-manager hedge funds appear to be healing in terms of both asset flows and returns, hedge funds of funds continued their relative underperformance in 2010. The Morningstar Hedge Fund of Fund Index rose only 4.1% in 2010, a full 6 percentage points less than single-manager hedge funds. Hedge funds of funds in Morningstar's database also experienced significant outflows in 2010 through November, totalling almost USD10.1 billion.

December returns for the Morningstar Hedge Fund Indexes are based on funds that reported as of January 21, 2011. December returns for the Morningstar MSCI Hedge Fund Indexes and November asset flows are based on funds that reported as of January 11, 2011. Hedge fund investors, managers, consultants, and advisors can access additional information through the Morningstar® Alternative Investment Center, formerly Morningstar Altvest, the company's research platform designed specifically for hedge funds, or Morningstar Direct, the company's global research platform for institutions.