The currency-hedged Morningstar MSCI Composite Index climbed 2.8 per cent for the month and 4.3 per cent for quarter.

"Hedge funds ended the third quarter with a bang," says Nadia Papagiannis, alternative investment strategist for Morningstar. "All strategies profited, as equities, bonds, commodities, and currencies rallied."

US stocks, as measured by the S&P 500 Index, experienced their best September in 71 years, on the news of more potential easing by the Federal Reserve and better than expected economic data with payrolls and manufacturing. The Morningstar US Equity Hedge Fund Index rose 6.0 per cent in September against the S&P 500's 8.9 per cent climb.

European stocks, as measured by the MSCI Europe NR Index, increased 11.0 per cent, as positive GDP and sentiment data outweighed credit concerns over Ireland and Portugal. The Morningstar Europe Equity Hedge Fund Index rose 7.8 per cent during the month.

In mid September, the Federal Reserve's statements suggesting continued quantitative easing triggered a US dollar freefall against several currencies and near-record lows in two- and five-year Treasury yields. This provided trading opportunities for funds in Morningstar's debt arbitrage and global non trend hedge fund indices, which gained 3.6 per cent and 4.0 per cent respectively in September, and 6.6 per cent and 4.6 per cent for the quarter.

The US dollar's plunge contributed to the rise in several commodities, including gold, silver, sugar, and cotton. Funds in Morningstar's Global Trend Hedge Fund Index, which profit from price trends in commodity futures and other derivatives, saw a 6.1 per cent rise in September, their best month since early 2008.

Hedge fund of funds in the Morningstar's database also posted their best results since 2008. The Morningstar Hedge Fund of Funds Index outpaced the Morningstar Multi-Strategy Hedge fund index by almost a full percentage point in the third quarter of 2010, after having underperformed in the previous six quarters.

Merger and acquisition activity picked up in the third quarter of 2010, particularly in emerging markets and the energy sector. Funds in the Morningstar Corporate Action Hedge Fund Index, which engage in strategies such as merger arbitrage, rose 4.3 per cent. Acquisition activity through leveraged buyouts helped to spur new corporate high-yield debt issuance, which almost broke 2009's year-long record this month.

The appetite for high-yield bonds and risky assets in general boded well for funds in Morningstar's Distressed Securities Hedge Fund Index, which increased 2.6 per cent in September.

Volume in convertible bond issuance also improved in the third quarter, especially in Asia. The Morningstar Convertible Arbitrage Hedge Fund Index climbed 7.4 per cent in the three months ending 30 September.

In addition to a favourable market environment in September, hedge funds also appear to be back in favour with investors. After two months of net outflows, single-manager hedge funds in Morningstar's database saw USD1.3bn in inflows in August. Convertible arbitrage hedge funds attracted the most assets in August, USD773m.

For the year to date through August, hedge funds in the database have leaked USD4.4bn, although funds in the global non-trend, US equity, and corporate actions categories experienced inflows of USD3.3bn, USD1.4bn, and USD1.2bn, respectively.