Despite a fall of 0.2 per cent in May, the Morningstar MSCI Composite Hedge Fund Index remains up by 4.9 per cent for the year to date.

Morningstar reported that over the trailing 12 months, the index rose 8.6 per cent.

“A growing risk appetite in the US pushed small cap equities and distressed securities higher in May. Hedge funds investing in these asset classes delivered the month’s strongest performance,” said Philip Guziec, alternative investments strategist at Morningstar.

Overall, global equity market performance proved lacklustre in May, though, and the MSCI World NR Index remained flat for the month. Japanese equities swung dramatically, with the Nikkei 225 Index rising 11.3 per cent by mid-month on euphoria over the Bank of Japan’s announced massive monetary stimulus plan designed to drive inflation up to 2 per cent, the firm said.

However, the rally ultimately collapsed in response to weak Chinese manufacturing data, including a 7 per cent one-day drop on May 23, which left the index down 0.7 per cent for May. Hedge funds investing in this region provided relative downside protection though, as the Morningstar MSCI Asia Pacific Hedge Fund Index rose 1.32 per cent. Emerging market hedge funds also sheltered investors in May. The Morningstar MSCI Emerging Markets Hedge Fund Index inched up 0.6 per cent, while the MSCI Emerging Market Stock Market Index sank 2.6 per cent.

The firm said that the fixed income markets also declined broadly in May on discussions by the Federal Reserve that it might taper its quantitative easing programme. These concerns drove down the Barclays US Aggregate Bond TR Index 1.8 per cent. 

While global markets reacted negatively to rising US interest rates, fixed income hedge fund managers were able to keep the Morningstar MSCI Fixed Income Hedge Fund Index unchanged in May, and the Morningstar MSCI Specialist Credit Index managed to eke out an increase of 0.1 per cent. The environment proved healthier for fixed income arbitrage strategies, as the Morningstar MSCI Fixed Income Arbitrage Hedge Fund Index turned in a positive 0.5 per cent.

Meanwhile, hedge funds investing in riskier assets like distressed securities fared best though, as risk appetites continued to rise. The Morningstar MSCI Distressed Securities Hedge Fund Index rose 2.6 per cent in May.

The Morningstar MSCI Composite Hedge Fund Index is an asset-weighted composite of nearly 1,000 hedge funds in the Morningstar Hedge Fund database.