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Hedge funds winners and losers: Risk gets rewarded

If hedge fund investors in 2017 can learn anything from 2016, it's that not all funds are created equal.

Though hedge fund returns again fell short of some popular market benchmarks, the year featured some standout performance from various strategies. Risk drove returns, a strategy that could be a winner again in a year where volatility is expected to increase.

Activist investors and those focused on rescuing troubled companies both beat the S&P 500 for the year. Event-driven strategies also performed relatively well, narrowly missing the benchmark, while credit strategies also presented solidly positive returns, according to firms that track hedge fund performance.

As an industry, the HFRI Fund Weighted Composite Index returned 5.6 percent. In a year that featured record redemptions and miserable performance by a few high-profile names, industry spokesmen focused on the positive.

"Following a disappointing decline in 2015, hedge fund performance in 2016 was the highest since 2013 and not only tops indices of global equities, but also the annualized HFRI performance over the last five and 10 years," said Kenneth Heinz, president of HFR. "The recent (post-election) increase in investor risk tolerance is likely to drive continued performance and capital gains into mid-2017."

HFR's index of distressed-focused funds returned 13.4 percent for the year. Event-driven strategies as a whole returned 10.2 percent. That compares with the S&P 500, which posted a price gain just shy of 10 percent.

High wire act risk
Chung Sung-Jun | Getty Images

However, the comparison to the basic market index isn't a completely fair one. Hedge fund investors look not only to absorb gains but also to protect themselves against dips.

The year was a roller coaster for Wall Street, with the market tumbling early, recovering through midyear, trading in a volatile range through November, then rallying strongly after the presidential election.

Amid the ups and downs, investors found opportunity.

Despite the high-profile withdrawals, hedge funds actually ended the year with more assets. Net asset flow — inflows minus redemptions — reflected a loss of $51.4 billion, but performance more than negated that and boosted total assets to $2.97 trillion, or 2.6 percent higher than 2015, according to HFR.

Finding the right country to invest in also helped.

Russia was a big winner for the year in the equity markets, and hedge funds that focused on the country showed a 28.6 percent gain, according to eVestment. Brazil, though, was the best country with a 33.3 percent gain, reversing an awful year that saw a 28.6 percent drop. HFR's Latin America index showed a 26.2 percent gain.

It was a year where risk paid off.

Losers centered on macro strategies that take big-picture approaches on various countries. As a group they returned just 1.5 percent.

Elsewhere, equity market neutral strategies that try to exploit price differences on stocks in the same sectors fell flat, gaining just 1.6 percent, according to HFR. Technology-focused funds also did poorly, up just 0.8 percent.