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The economic shock to Japan following the country's earthquake, tsunami, and ensuing nuclear crisis affected many hedge funds in March, particularly those in the Morningstar Developed Asia Equity and the Morningstar MSCI Japan Hedge Fund Indexes, which fell 0.3% and 2.3%, respectively. Although the events in Japan reverberated across the globe and caused stock market volatility to spike to its highest level in nine months, recovery came quickly, and the Morningstar Global Equity Hedge Fund Index ended the month up 1.2%.

"A sharp increase in volatility and continued geopolitical unrest threatened to stunt hedge fund performance in March, but most strategies finished the month positive with strong overall first-quarter gains," said Mallory Horejs, alternative investment analyst for Morningstar.

All other equity strategies continued to climb higher in March. The Morningstar Emerging Markets Equity and the currency-hedged Morningstar MSCI Emerging Markets Hedge Fund Indexes, which rose 1.4% and 2.4%, respectively, saw the strongest growth. March performance for these hedge fund indexes trailed that of the MSCI Emerging Market Equity Index, but it pulled both indexes into positive territory for the quarter. The two emerging market hedge fund indexes finished the quarter up 1.2% and 0.7%, respectively.

European stock markets stayed strong throughout the quarter, despite the ongoing sovereign debt crisis in Ireland, Portugal, and Greece. Accordingly, the Morningstar Europe Equity Hedge Fund Index increased 1.3% in March and 4.4% for the quarter. U.S. stocks, however, lost momentum in March in light of rising uncertainty regarding monetary policy, a discouraging slump in housing starts, and a peak in oil prices. Nonetheless, the Morningstar U.S. Equity and Morningstar U.S. Small Cap Equity Hedge Fund Indexes still enjoyed modest monthly increases of 0.2% and 0.5%, respectively. The Morningstar U.S. Small Cap Equity Hedge Fund Index outpaced all other hedge fund indexes in the first quarter, rising 4.8%.

Despite resilience across equity markets, macro-economic hedge fund strategies failed to deliver in March. The Morningstar Global Non-Trend Hedge Fund Index decreased 1.7% this month, erasing February's jump, and placing the index last with a 1.9% quarterly decline. Morningstar's Global Trend Hedge Fund Index, which includes funds that trade futures primarily according to momentum strategies, did not fare much better. It declined 1.3% in March but managed to end the quarter in the black, at 0.4%.

Relative-value strategies delivered their fourth consecutive month of positive returns in March, as the Morningstar Convertible Arbitrage, Morningstar Debt Arbitrage, and Morningstar Equity Arbitrage Hedge Fund Indexes advanced 0.9%, 0.6%, and 0.8%, respectively. The Morningstar MSCI Merger Arbitrage and the Morningstar Corporate Actions Hedge Fund Indexes, which increased 1.9% and 3.4% during the first quarter, respectively, benefited from a surge in worldwide M&A activity, which reached its highest levels since 2008.

Flows into hedge funds also reached recent highs. Hedge funds in Morningstar's database netted $5.2 billion of inflows in February, the largest monthly inflow figure since August 2009. Almost all categories gained assets, although the bulk went to funds in Morningstar's European equity ($872 million), U.S. equity ($1.1 billion), and global trend ($1.6 billion) hedge fund categories. Emerging market equity and global non-trend were the only hedge fund categories to leak assets in February, as investors reacted to increased geopolitical unrest, particularly across North Africa and the Middle East.

Funds of hedge funds in Morningstar's database also saw inflows in February of $669 million, following five consecutive months of sizeable outflows. The Morningstar Hedge Fund of Funds Index slightly outperformed the overall hedge fund index in the month of March, with a 0.3% rise, but the average hedge fund of funds underperformed both the overall hedge fund index as well as the average multi-strategy hedge fund during the first quarter of 2011.

March returns for the Morningstar Hedge Fund Indexes and the Morningstar MSCI Hedge Fund Indexes are based on funds that reported as of April 18, 2011. February asset flows are based on funds that reported as of April 14, 2011. Hedge fund investors, managers, consultants, and advisors can access additional information through the Morningstar® Alternative Investment Center(SM), formerly Morningstar® Altvest(SM), the company's research platform designed specifically for hedge funds, or Morningstar Direct(SM), the company's global research platform for institutions.

(press release)

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