Hedge Funds Start Year to the Upside

Hedge funds began to compensate for a dismal performance in 2008 by starting off the new year with heady gains, according to two research groups.

Hedge Fund Research reported on Friday that its composite hedge-fund index rose 0.39% in January, while Hennessee Group said Monday that its hedge-fund index was up a sharper 1.1%. When compared with broad market indices, like the S&P 500's and Dow Jones Industrial Average's 9% declines, hedge funds outperformed by about 10 percentage points.

The strongest gains last month were made by investing in the bond markets, shorting the equity markets, or using arbitrage strategies to benefit from market dislocations. Those that added to positions with bank debt or high-yield credit did particularly well, as high-yield bonds gained 5.8% and leveraged loans rose 6.9%.

Among funds that bet against stocks, many benefited from predicting earnings misses, especially for companies that make or sell consumer products like Sara Lee (SLE Quote), Kraft (KFE Quote), Burger King (BKC Quote) or Toyota (TM Quote).

Others posted gains by buying stocks in defensive sectors like health care, which outperformed the market as investors flocked to defensive names such as Wyeth (WYE Quote), Aetna (AET Quote), Boston Scientific (BSX Quote), Humana (HUM Quote), Medtronic (MDT Quote), Schering-Plough (SGP Quote) or UnitedHealth (UNH Quote).

At the other end of the dial, long equity-based funds dragged on overall results, especially emerging-market funds, amid a flight to "safer" investments at home, like U.S. Treasury bonds.

Lee Hennessee, managing principal of Hennessee Group, believes that the tides may soon turn for the equities markets, since $6.5 billion poured into mutual funds during the last week of January.

"[I]f this trend continues," says Hennessee, "it could be basing and a bullish sign for equity markets."