This was against the MSCI World Index's 8.9 per cent drop and the BarCap Global Aggregate Index's 3.3 per cent decline.

Morningstar says relative-value trading became profitable in January, especially in bonds, as increased liquidity from global fiscal and monetary actions and new debt issues led to narrowing spreads. The Morningstar with MSCI Relative Value Hedge Fund Index increased 2.2 per cent in January, while the Morningstar Debt Arbitrage Hedge Fund Index rose 0.6 per cent.

Also benefiting from narrowing spreads, convertible bonds continued their December rebound. The Morningstar Convertible Arbitrage Index rose 1.0 per cent in January. Large allocations to convertible arbitrage strategies also drove up the Morningstar Multi-strategy Hedge Fund Index, which increased 1.1 per cent.

Increased liquidity also prompted a surge in January US merger and acquisition volume, even though the number of announced deals dwindled. Funds in the Morningstar Corporate Actions Hedge Fund Index, which aim to profit from such deals, rose 0.7 per cent.

"Some liquidity returned to the credit markets in January, helping certain hedge fund strategies, but even hedge funds trading equities persevered through January's tough markets," says Morningstar hedge fund analyst Nadia Papagiannis. "Overall, hedge funds held their own in January."

News of high unemployment and economic contraction battered US and European stocks, but the Morningstar US Equity Hedge Fund Index ended the month up 0.4 per cent.

The currency-hedged Morningstar with MSCI Europe Hedge Fund Index also rose 0.5 per cent while the Morningstar Europe Equity Hedge Fund Index declined 3.7 per cent. Some European hedge funds made local currency gains, but the US dollar appreciated against the Euro.

Emerging markets also suffered, as investors fled from Eastern European and Russian stocks, although Latin American stocks held steady. The Morningstar with MSCI Emerging Market Hedge Fund Index dropped 0.4 per cent in January.

The rise in the US dollar created profits for some price-trend-following and global-macro non-trend funds in January, but volatility across equity, government bond, and commodity markets throughout the month led to trading losses.

The Morningstar Global Non-Trend Hedge Fund Index rose 0.1 per cent while the Morningstar Global Trend Hedge Fund Index declined 1.6 per cent.

Investors continued to pull out of hedge funds, withdrawing USD26bn in December and USD70bn for the year. Europe and US equity hedge funds saw the largest redemptions, losing USD14.8bn and USD18.3bn respectively in 2008.