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Overview
On September 15, with 2,537 hedge fund products reporting performance, the HFN Hedge Fund Aggregate Index was +1.74% in August and +13.87% in 2009. The S&P 500 Total Return Index (S&P) was +3.61% in August and +14.96% YTD.

Hedge Fund Industry Highlights:
• August performance was positive for the sixth straight month; the longest streak of positive performance since July 2007, the final month of a twelve month positive run.
• Total industry assets rose 2.56% to an estimated $1.886 trillion. Investor inflows picked up pace again in August.
• August performance was led by Finance Sector, Distressed and Mortgage related strategies. Short Bias, Technology Sector and Macro funds lagged.

NOTE: As of September 15, 2009 HFN changed the names of all benchmarks from “Average” to “Index”. The methodology for calculations remains the same.

As was the case in July, positive hedge fund performance in August was driven by strong equity markets. Directional fixed income strategies continued to add to what appears will be a record year. Volatility in currency and commodity markets, most notably in the energy sector, likely contributed to slightly negative average performance from global macro managers.

Equity market (S&P 500 TR) performance overtook average hedge fund returns for 2009 in August after rising more than 40% since February. To give a sense of equity market volatility, in 2009 the HFN Hedge Fund Index has either underperformed or outperformed the S&P 500 TR by more than 500 basis points in all but three months. The average differential between the two benchmarks during these months was 730 basis points. Since the beginning of 1997, the historical average monthly differential is only 280 basis points.

Regional Overview:
Emerging market hedge fund performance was mixed in August after several months of broadly strong returns. The result was that average emerging market returns lagged the broad industry for the first month since February. The underperformance in that month was the final month of a string of 9 straight months of underperforming emerging market exposure.

The HFN Emerging Markets Index was +1.66% in August and is +27.38% in 2009. Emerging market returns for the month were led by funds with primary exposure to Latin America’s markets. While Brazilian equities appeared to provide the bulk of above average positive returns, the best August performance came from exposure to Argentine distressed securities. China was the source of the only negative average emerging market returns in August, although China funds did produce the best returns one month prior.

Monthly Asset Flow Estimates
• Total hedge fund assets at the end of August were estimated at $1.886 trillion, an increase of 2.56%, or $47.09 billion since July.
• Performance accounted for $27.9 billion of the increase and investor allocations accounted for $19.6 billion.
• The rate of organic growth (asset rise due to investor allocations) increased in August to 1.05%, nearly matching rates seen in June.

The increased rate of investor allocations in August is a very positive sign for the industry after the dip in investor allocations in July. Following the nine straight months of outflows ending in April 2009, flows turned positive in May and increased in June before declining in July. During this recent stretch, the level of redemptions remained steady which was an indication that the surge of outflows had ended and increases in inflows resulted in overall industry growth.

Sub-sector Specific Flows
• Managers located in Europe had the highest rate of inflows in August followed by Asia, then North America.
• The rate of allocations to fixed income strategies outpaced equity related strategies in August for the first time since May, but commodity related strategies had the highest broad sector inflows.
• Funds investing primarily in mortgage related securities had the highest rates of allocations among fixed income strategies and allocations to broad corporate bond strategies outpaced sovereign bond strategies for the second straight month.
• Convertible bond strategies saw a net inflow from investors for the first time in 14 months.
• Despite lagging other main sectors, equity strategies had their highest rate of post-crisis allocations.
• Investors allocated to relative value strategies at a faster rate than directional long/short for the first time since the financial crisis abated.

August Performance Review
Fixed Income (FI) Strategies Mortgage related strategies continued to post the best fixed income focused fund returns. The average mortgage focused fund returned +3.43% in August and the HFN Mortgages Index is +37.46% YTD, by far the best HFN Strategy Specific Index in 2009. The higher end of the risk spectrum is once again producing the best returns as distressed debt specific strategies returned an average of +5.31% in August and high yield strategies were +2.86%.

Equity (EQ) Strategies
Average performance across EQ related strategies lagged fixed income funds for only the second time in the last seven months. The HFN Long/ Short Equity Index was +2.28% in August and +16.46% YTD. Average returns from EQ focused funds continued to outperform the S&P in 2009 and are on pace for their best performance in more than 5 years.

Commodity and Foreign Exchange (FX) Related Strategies
Funds focusing on foreign exchange markets had a difficult time in August. The U.S. Dollar Index had a volatile month, but ended August mostly unchanged. The average FX focused fund was -0.41% during the month, the third consecutive month in which these funds have produced average losses. For the year, the average return from FX focused funds is +1.09%.

Going Forward
With few exceptions, global equity markets in September have continued to rise. Rising industrial production in August, even ex-motor vehicles and parts sales, is an indication that, at least in the U.S., the recession may have ended.

From hedge fund investors, the high rate of increase in allocations to corporate bond related strategies versus equity strategies could imply two things, 1) there may be increasing confidence in corporate profits and 2) despite this confidence, investors may be cautious about equity market valuations following the massive run-up over the past 6 months.

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