GLOBAL - Assets managed in the hedge fund industry are almost back to their pre-crisis highs after a record quarterly increase in the fourth quarter of 2010, according to the latest figures from hedge fund research and indexing company HFR.

Investors committed $13.1bn (€9.7bn) in net new capital to the industry between October and December, which, together with the fourth quarter's 5.5% performance boost, brought total industry assets to $1.9trn, less than $20bn short of the peak reached in the second quarter of 2007 and 44% higher than the levels plumbed in the first quarter of 2009.

Kenneth Heinz, president at HFR, said: "The industry did grow more year-on-year during 2006 and 2007, but Q4 2010 represents the strongest quarterly increase in assets on record."

In another sign of growing risk appetite among hedge fund investors, while more than 80% of new inflows were allocated to firms with more than $5bn under management over the course of the year as a whole, only 52% went into the biggest firms during the final quarter.

"The favour shown to larger firms is still a powerful trend," Heinz said, "but we have seen some significant moderation to it."

The old industry axiom 'December was a good year for hedge funds' was borne out in 2010, with much of the year's returns bunched into the fourth quarter.

Nonetheless, a 10.5% 2010 return for the HFRI Fund Weighted Composite index will have left most investors happy.

The relative-value strategies performed best, with convertible arbitrage topping the tree with a 13.1% return - much of which, conversely, was achieved in the first half of the year when markets were more volatile.

Heinz noted that three of the four major strategy groups were now approaching high-water mark levels - with the exception of equity hedged, catching up fast in the second half of 2010.

Figures from the EDHEC-Risk Alternative indices also show convertible arbitrage leading the way, with a 12.2% return in 2010.

However, fund of funds investors may not be so satisfied. At 5.6%, the HFRI Fund of Fund Composite index underperformed the broad index by 4.89 percentage points, after underperforming by 8.52 percentage points in 2009.

Indeed, since 1998, the fund of funds index has only outperformed the year-on-year return of the broad index twice, in 2002 and 2007.

Again, the EDHEC-Risk Alternative indices bear this out: at 5.2% for 2010, funds of funds would have posted the worst return on any strategy were it not for the fact EDHEC publishes a separate index for short selling, which ended the year down 16.9%

So, while HFR notes that funds of funds saw net inflows in both the third and fourth quarters of 2010 - the first consecutive quarterly net inflow since the first half of 2008 - that merely stresses how bad the first half of the year was: full-year net outflows from funds of funds hit $11.8bn.

Heinz said: "It's not news that many investors soured on the commingled fund of funds business model in 2008 and 2009 over concerns about performance, costs, liquidity and due diligence when the Madoff affair came to light. Many are clearly choosing to allocate directly to funds."

The old fund of funds business model was purely about offering capacity and access to the best managers and manager selection, Heinz said, whereas now the fund of funds industry must offer a convincing case in those terms, but also in terms of "people, infrastructure and technology".

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