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"Hedge funds ended the third quarter with a bang," said Nadia Papagiannis, alternative investment strategist for Morningstar. "All strategies profited, as equities, bonds, commodities, and currencies rallied."

U.S. stocks, as measured by the S&P 500 Index, experienced their best September in 71 years, on the news of more potential easing by the Federal Reserve and better than expected economic data with payrolls and manufacturing. The Morningstar U.S. Equity Hedge Fund Index rose 6.0% in September against the S&P 500's 8.9% climb. European stocks, as measured by the MSCI Europe NR Index, increased 11.0%, as positive GDP and sentiment data outweighed credit concerns over Ireland and Portugal. The Morningstar Europe Equity Hedge Fund Index rose 7.8% during the month.

In mid September, the Federal Reserve's statements suggesting continued quantitative easing triggered a U.S. dollar freefall against several currencies and near-record lows in two- and five-year Treasury yields. This provided trading opportunities for funds in Morningstar's Debt Arbitrage and Global Non Trend Hedge Fund Indexes, which gained 3.6% and 4.0%, respectively in September, and 6.6% and 4.6% for the quarter. The U.S. dollar's plunge contributed to the rise in several commodities, including gold, silver, sugar, and cotton. Funds in Morningstar's Global Trend Hedge Fund Index, which profit from price trends in commodity futures and other derivatives, saw a 6.1% rise in September, their best month since early 2008.

Hedge fund of funds in the Morningstar's database also posted their best results since 2008. The Morningstar Hedge Fund of Funds Index outpaced the Morningstar Multi-Strategy Hedge fund index by almost a full percentage point in the third quarter of 2010, after having underperformed in the previous six quarters.

Merger and acquisition activity picked up in the third quarter of 2010, particularly in emerging markets and the energy sector. Funds in the Morningstar Corporate Action Hedge Fund Index, which engage in strategies such as merger arbitrage, rose 4.3%. Acquisition activity through leveraged buyouts helped to spur new corporate high-yield debt issuance, which almost broke 2009's year-long record this month. The appetite for high-yield bonds and risky assets in general boded well for funds in Morningstar's Distressed Securities Hedge Fund Index, which increased 2.6% in September. Volume in convertible bond issuance also improved in the third quarter, especially in Asia. The Morningstar Convertible Arbitrage Hedge Fund Index climbed 7.4% in the three months ending September 30.

In addition to a favorable market environment in September, hedge funds also appear to be back in favor with investors.

After two months of net outflows, single-manager hedge funds in Morningstar's database saw $1.3 billion in inflows in August. Convertible arbitrage hedge funds attracted the most assets in August, $773 million. For the year to date through August, hedge funds in the database have leaked $4.4 billion, although funds in the Global Non-trend, U.S. Equity, and Corporate Actions categories experienced inflows of $3.3 billion, $1.4 billion, and $1.2 billion, respectively.

September returns for the Morningstar Hedge Fund Indexes are based on funds that reported as of October 18, 2010. September returns for the Morningstar MSCI Hedge Fund Indexes and August asset flows are based on funds that reported as of October 13, 2010. Hedge fund investors, managers, consultants, and advisors can access additional information through the Morningstar(R) Alternative Investment Center(SM), formerly Morningstar(R) Altvest(SM), the company's research platform designed specifically for hedge funds, or Morningstar Direct(SM), the company's global research platform for institutions.

Morningstar has approximately 11,000 hedge funds and funds of hedge funds in its database. The Morningstar 1000 Hedge Fund Index, a global, broadly representative benchmark for hedge fund performance, has return history from January 2003. The index comprises the top 90% of eligible assets in Morningstar's hedge fund database. For the purposes of the index, Morningstar counts funds with shared portfolios as a single hedge fund; funds of hedge funds are excluded from consideration. The index is updated daily for the previous month-end, rebalanced monthly, and reconstituted semi-annually. In addition, Morningstar has 17 category indexes and four broad category indexes based on Morningstar's strategy-specific classification system for hedge funds. Morningstar's hedge fund indexes are not investable.

(press release)

Full performance table: Source

About Morningstar, Inc.
Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offers an extensive line of Internet, software, and print-based products and services for individuals, financial advisors, and institutions. Morningstar provides data on approximately 360,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 4 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. The company has operations in 21 countries... Corporate website: www.morningstar.com

-KM