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January was a very good month for hedge funds.

Lifted by a strong stock market, hedge fund performance was up 3.65% for the month, according to Hedge Fund Research. That beat the 2.55% returned by the

S&P 500

over the same period.

Among other gauges, the MSCI Hedge Invest Index rose by 2.29% in January, while the Standard & Poor's HFI Index posted a preliminary 2% return for January, almost as much as the annualized return of 2.28% last year. The differing returns reflect the indices' varied components and methodologies.

"Equities were very strong and drove the hedge fund performance for January," said Josh Rosenberg, president of Hedge Fund Research.

"Everything clicked last month," says Justin Dew, hedge fund analyst at Standard & Poor's.

Fund managers benefited from gains in the energy, emerging markets and technology sectors.

The January result posted by HFR exceeded last year's December return by 1.76 percentage points and contrasted with the negative 0.2% performance of a year ago. The annualized performance last year was 9.35%.

Among sectors, the front-runners were emerging markets (up 6%) and energy funds (up 6.77%), as well as sector funds such as healthcare/biotechnology (6.32%), according to HFR. Long/short managers who simultaneously buy and short stocks posted a 4.48% return, according to S&P, with a 5.47% return for the non-U.S. component and 3.50% for the U.S. component.

Arbitrage strategies also did well due to a rise in volatility. The Hennessee Arbitrage/Event Driven Index produced by Hennessee Group was up 2.66% as the category benefited from a surge in deals.

One surprise was the return of convertible arbitrage, a loser last year, but a style that might be in the early stages of recovery. Its return was a positive 2.79% last month according to HFR, and positive 2.50% according to MSCI.

Convertible arbitrage is making a comeback because volatility is rising and bonds have come down in price. Merger arbitrage also saw a good month, says Charles Gradante, a principal at Hennessee, driven by deals like

Boston Scientific's


acquisition of


and the




Not surprisingly, short-sellers were the poorest performers. Their performance was a negative 2.37% last month according to MSCI Hedge Invest Index, and negative 1.66% according to HFR.

The divergent results produced by the different data companies has been a problem in hedge fund performance tracking. But even when taking into account those discrepancies, performance remained strong all across the board. The numbers for most of those indices vary from positive 2% (S&P HFI) to positive 3.65% (HFRI).

In general, investable indices -- such as the MSCI or S&P HFI indices, for instance -- produce lower returns. That is because they are live indices reflecting the performance of funds in which money is actually invested.

The assets are held by a managed account platform provider and hedge funds have no other option but to report their results. Because they are live, investable indices take into account the bad performance of "dead funds," or funds that have liquidated, which is why they are not impacted by what is commonly called survivorship bias.

Noninvestable indexes (HFRI, Hennessee), on the other hand, may not take into account the performance of funds that are shutting down or have stopped reporting. That is one of the reasons why the overall performance of noninvestable indices tends to be overstated.

Another significant difference in methodology is whether the index is asset weighted or not. When asset weighted, the index takes into account the size in dollar amount of each underlying manager. If not, the index is equally weighted. There is no clear way to conclude which one of those methods gives the highest performing index results; but certainly, they will generate discrepancies.

The number of funds in the index is also significant. Investable indices will be more concentrated than noninvestable ones. MSCI, for instance, uses 131 funds, while the HFRI Index has 1,600 funds. Again, it doesn't mean that one method will generate higher returns than the other, but the results will reveal significant discrepancies from an index provider to another.