The fund of hedge fund sector experienced strong net inflows during the third quarter, with positive absolute returns in each of the individual months, according to a report by Standard & Poor’s.

The report, by analyst Randal Goldsmith, says funds of hedge funds returned over four per cent in the third quarter and are up over eight per cent during the year to date, with funds that focus on emerging markets leading the recovery.

Gross and net exposure remains below historical levels, but net market exposures increased in the third quarter because hedge fund managers held in fund of hedge funds portfolios have not been convinced on the sustainability of the rally in the markets. This has been particularly the case in Europe, where returns have generally been disappointing despite competitive returns in the underlying equity markets.

Fund of hedge funds maintained team resources through the past year despite a sharp decline in fee income. Some of them have added resources, generally to reinforce operational due diligence.

Among S&P Fund Services rated funds of hedge funds, GAM Multi-Emerging Markets has returned 20.5 per cent, Permal Asian Holdings has returned 24.8 per cent and Permal Emerging Markets Holdings has returned 26.1 per cent.

Permal Japan Holdings was a positive surprise returning 16 per cent over 2009 to the end of September despite the Japanese market's poor performance as a laggard in the equity markets recovery.