In a remarkable rebound, the hedge fund industry had its best year in a decade in 2009 and returned 18.6 per cent, says Credit Suisse/Tremont, the fund tracker.

The convertible arbitrage sector performed the best, returning 47.3 per cent for the year through till December. The event driven strategy – the largest sector by weight, at 25.6 per cent of the industry – attracted a lot of investor attention as mergers and acquisitions picked up strongly after the crisis, and consolidations and restructuring are expected to remain important this year. It posted a strong performance of 20.4 per cent for the year.

The dedicated short bias and managed futures sectors were the only ones to finish the year in the red, at -25 per cent and -6.6 per cent respectively. However they were the only sectors to finish 2008 in positive territory.

Improved market conditions allowed many hedge funds to recover from the massive drawdown experienced in 2008, when overall industry performance fell 19.5 per cent from 30 June to 31 December 2008.

According to Credit Suisse/Tremont 76.7 per cent of losses incurred in the industry in 2008 were recovered last year, and 28 per cent of funds have now regained all losses and are either on par with or have surpassed their previous peak performance.

While the MSCI World Index returned 27 per cent last year, global equity markets still regained a smaller share of overall losses, and the current drawdown remains at 26.5 per cent.

This positive performance has bolstered the liquidity profile of the industry as compared with the end of 2008, when Credit/Suisse Tremont estimates that $174 billion out of a total $1.5 trillion of hedge fund assets were impaired. $102 billion of these have now been returned to standard liquidity.

After it was brought to light in 2008 that some investors knew little about the liquidity and quality of the assets they held, last year saw trends towards decreasing lock up periods, increased transparency and a renewed focus on client relationships.

With $99 billion was pulled out of the industry in 2008, and as it ended the year mired in problems with redemptions and losses, few would have expected asset flows to turn positive in the third quarter of 2009. Yet in the fourth quarter the industry experienced its second consecutive quarter of net inflows, as $12 billion of assets flowed in. The majority of these went into the long/short equity sector, attracted by bullish equity markets and the liquidity of the strategy.

As high net worth individuals and institutional investors faced tighter liquidity constraints following the financial crisis, they were less willing last year to reallocate assets to hedge funds. Credit Suisse/Tremont notes that managers dealt with this by turning to a new investor base, as they increasingly sought to explore opportunities through retail distribution channels. They did this through creating exchange traded products, mutual funds and UCITS III funds.

However despite the increasing number of “hedge-fund-like” funds, assets under management in the hedge fund industry are predicted to rise throughout 2010, after having ended 2009 at around $1.5 trillion, and almost double to $2.6 billion by 2013, according to Credit Suisse/Tremont.