Hedge Funds Outperform S&P in Q407

January 17, 2008 (PLANSPONSOR.com) - Hedge funds in Morningstar's database, excluding funds-of-funds, returned an average of 1.98% during the fourth quarter of 2007, outperforming the S&P 500 Index and the MSCI World Index in U.S. dollars.

Hedge funds overall gained 14.13% for the year, Morningstar Hedge Fund Analyst Nadia Van Dalen said in a news release. Emerging-markets equity hedge funds were the clear winners in 2007 with a 32% annual return.

With a 16% gain, global equity hedge funds were the second-best performing category, returning about nine percentage points more than its benchmark, the MSCI World Index, the news release said. The funds also outperformed the index in the fourth quarter.

The U.S. equity category posted a modest gain for the quarter with 0.3%, but substantially surpassed the S&P 500 Index’s returns, both for the quarter and the year. The U.S. equity small-cap category, which posted a small gain of 0.8% for the fourth quarter, outperformed the U.S. equity category for the year with 13.6%.

The Europe equity category returned 14.1% for the year after a fourth-quarter return of 0.3%, outpacing the MSCI Europe Index for both time periods. The developed Asia equity category posted a 6% return at year-end and a negative 2% return at quarter-end.

According to the Morningstar data, short equity hedge funds neared the top of the category charts in the fourth quarter with a 6.2% return, and year-end returns for short equity funds reached 7.8%.

Global trend hedge funds, those that systematically follow price trends in futures and currencies, had an annual return of 14.7%. These funds topped the chart in the fourth quarter with a 6.5% return. Global non-trend hedge funds returned 14.9% for the year and 4.3% in the fourth quarter.

Prospects for the corporate actions category dwindled, Morningstar said, as credit conditions worsened in the second half of 2007. These funds eked out a 0.3% gain in the fourth quarter and 8.5% for the year. Distressed securities hedge funds posted a negative 0.5% return at quarter-end and a 5.1% return at year-end.

The convertible arbitrage category performed the worst among all categories, with a negative 2.1% return in the fourth quarter and a 2.4% return for the year. Debt arbitrage hedge funds managed a positive fourth quarter and yearly return of 1.5% and 12.6%, respectively, while equity arbitrage hedge funds returned 2.9% for the quarter and 12.4% for the year.

Finally, multi-strategy funds underperformed the average single-manager hedge fund, returning 13.4% for the year and 2.9% for the fourth quarter. Funds-of-funds slightly underperformed multi-strategy funds with 13.3% for the year and 2.6% for the quarter.