Investor confidence returns as hedge funds post best performance in a decade

The hedge fund industry posted its strongest gains since 1999, according to Hedge Fund Research.

The HFRI Fund Weighted Composite Index gained 20.1% in 2009, just 12 months after posting the worst calendar year loss in the history of the industry.

Investors allocated $13.8 billion of new capital to the industry in fourth quarter of 2009, the largest quarterly inflow since the first quarter of 2008. The increase had only a modest impact on full year capital flows as investors withdraw $131 billion overall in 2009.

Strong performance more than compensated for investor redemptions. Overall global hedge fund assets ended 2009 at $1.6 trillion, almost $260 billion higher than the asset low point in the first quarter of 2009. Despite this the industry was still $330 billion below the peak of $1.93 trillion set in the second quarter of 2008.

For the year the HFRI Fund Weighted Composite Index remained 4.5% below the peak performance level set in October 2007.

Not all funds shared in the recovery. Around 2,000 funds were liquidated since the start of the financial crisis. Just over half of all funds have returned to their respective high watermark levels in 2009.

In a reversal of the third quarter of 2009, investor allocations were primarily new capital into larger funds. Hedge finds with over $5 billion in assets under management (AUM) saw a net inflow of over $7.5 billion in the period.

Despite the diversified nature of the performance recovery, investors showed clear strategy allocations preferences in the fourth quarter of 2009. Over half of the capital inflow went into event driven strategies. This, said Hedge Fund Research, suggested investors are positioning themselves for continued opportunities in the credit, high yield and corporate markets.

Although the HFRI Macro Index posted only a modest 4.1% gain in 2009, investors allocated $4.5 billion of new capital to this sector. Over  $1 billion of capital went into funds focusing on Asia.

The market is seeing a surge of innovation to meet investor demands for better transparency and liquidity and a challenge to the 2-and-20 fee structure. According to Hedge Fund Research the average management fee is 1.6% and with incentive fees averaging 19.2%.

Funds are adapting to a new environment, reported Hedge Fund Research. Many funds that previously required lock ups have dropped this condition. Others have offered products with lower fees or hurdle rates in exchange for capital or term commitments. Transparency of fund operations is being offered to more investors.

“In many respects hedge fund performance in 2009 suggests an aggressive return of risk, essentially the reverse of the financial crisis of 2008. But this generalisation masks a significant evolution of the industry which has occurred,” said Kenneth Heinz, president of Hedge Fund Research.

“Many of the fund strategies that were most out of favour in 2008 became top performers in 2009,” he noted, adding that funds have responded to investor demands by offering more specialised exposures, modified terms and greater transparency.

Hedge Fund Research specialises in indexation and analysis of hedge funds. Its database includes fund level detail on historical performance and assets and company characteristics on the broadest and most influential hedge fund managers. The company produces over 100 indexes of hedge fund performance.