By: Alexander Ineichen.

Once upon a time, not so long ago, there was a bear named Winnie-the-Bear who lived in the Trillion Acre Wood. On some level, he was a silly old bear. Nevertheless, he was wondering what the fuss about hedge funds was all about. He invited his two best friends, George Jones, the famous hedge fund manager, and Ben Put, the famous academic and central banker since the 1980s, to the Trillion Acre Wood for a third chat on hedge funds (Act 1, Act 2).

Winnie-the-Bear: Thanks again for joining me. Hedge funds were unduly demonized. I think I got that. But what really is a hedge fund?

Ben Put: Hedge funds are mysterious investment pools for well-heeled investors, who seek very high returns by taking very great risks. Hedge funds are run by sinister men who go around kicking dogs, taking candy from babies, and making massively leveraged bets in the equity markets.

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During our regular skimming of Web sites and newspapers over the past week or so, we at AllAboutAlpha.com came across a headline that at first blush seemed quite pithy and incredibly apropos: Should old articles be forgot.

Our first thought was that the piece, a New York Times op ed column, would be about some of the not-so-good scribblings published over the past year or decade – the outright made-up stuff a la Jayson Blair, or just the outright error-riddled stuff a la Alessandra Stanley – and how in a perfect world they might be forgotten.

But no, the piece was actually about how much information there is on the Internet – so much so that, according to the Times, it’s easy to miss a lot of really good stuff.

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To celebrate the dawn of our fifth year here at AllAboutAlpha.com, we are pleased to present the top 10 posts for 2009 (top 10 2008, 2007).

For a limited time, we have made each of these articles free without a subscription.  But don’t let this deter you from subscribing to our full archives and library – which now contain over 1,000 articles, 500,000 words and references to over 600 white papers, surveys and research studies on alternative investments.

So here it is (in reverse order):

10. If hedge fund “overcrowding” was bad for returns, is recent “undercrowding” going to be good? (originally posted: February)

The answer, according to many who observed the industry in 2009 was “yes”, the 2008 culling was good for business (for those that remained).

9. Is Merger Arbitrage going the way of the dodo? (originally posted: March)

Since March, the MFR Merger Arb index has risen every month.  So maybe the dodos will have to wait…

8. Academic study finds hedge funds more likely to sail into the sunset than go down in blaze of glory (originally posted: January)

There was indeed a lot of sailing into the sunset in 2009.  But as the year draws to a close, the amount sailing away now trails the amount of new boats being christened.

7. Hedge fund fame and fortune comes with strings attached says new paper (originally posted: August)

A lot of hedge fund investors and lenders exercised their “embedded option” to pull out this year.  But again, it appears this option exercising has now abated.

6. The new look for hedge funds this summer: mutual funds (originally posted: May)

Every year, we herald the coming “convergence” between hedge funds and mutual funds.  But with hedge funds coming off their best relative performance in history (2008), this year really did feel different.

5. With hedge funds back in the black, how are the hedge fund “clones” doing? (originally posted: June)

Ever since dolly sheep was cloned, scientists have been focused on the longevity of clones.  Will hedge fund clones experience the same fate as their mammalian cousins?

4. Jaeger predicts year of alternative beta, the death of “black boxes”.  Advocates “scenario based” portfolio construction (originally posted: January)

In January – a particularly brutal time for hedge funds – Lars Jaeger, the head of Partners Group’s new spin off, predicted serious turbulence for the industry.  Despite a change in fortunes for the industry, his predictions ring true today as much as ever.

3. Hedge funds plowing into stocks, short (originally posted: December)

Who’s that running by you into the burning theater as you run for the exit?

2.Study finds less than third of HFs actually pocket mythical “2 and 20″ (originally posted: March)

Hedge fund reporting can be quite an echo-chamber sometimes.  The common assumption that “2 and 20″ is “standard” may be a case in point.  By the end of the year, several other studies have finally begun to dispel this common myth.

1. A graphical look at hedge fund leverage (originally posted: March)

Another common assumption was also retired this year.  Thanks to banks’ double-digit leverage multiples, hedge funds look a lot more tame now.

That’s the kind of year it’s been. Downs and ups (in that order, thankfully).

As Barron’s points out this week, 2009 was a “year of recovery and transparency for the hedge fund industry.”

If there is any sort of broad, non-investment-related corollary that has emerged in the alternatives world this past year, it is the emergence of the “third party” in everything from middle- and back-office administration to independent portfolio valuation.

Not to be confused with the counter-party, which we discussed in detail here (or with a third party marketer), the “third party” has become the investment world’s new way of (hypothetically) ensuring that processes, numbers, valuation practices and everything in between are calculated and signed off on at arm’s length from the fund manager.

For hedge fund managers, particularly those with institutional allocations, it has quickly become a new reality: Either have your portfolio independently valued and verified, or lose the business.

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Here are a few news items that have caught our eye over the past couple of weeks.  Enjoy with a glass of eggnog and a sprinkle of nutmeg…

Hedge Funds Rebound From Record Losses: “…The industry is rebounding from record losses in 2008, though they paled in comparison to those seen by stock markets. Much of last year’s decline has been reversed in 2009, though redemptions as the stock market was tumbling crimped some investors.”

Hedges are showing signs of growth: “…12 months after the scandal hit the headlines, data shows confidence is returning – albeit slowly.  For the first time since mid 2008 the number of hedge fund launches has exceeded the number of closures….”

Insurers Will Come Back to Hedge Funds in 2010: “…it comes as no surprise that insurers reduced their hedge fund allocations through 2009, but the move isn’t permanent, especially given the returns posted by the sector this year.”

Funds Of Funds Losing Investors Even As Industry Grows: “…The huge loss of assets has not exactly led to a mass die-off of funds of funds, however…”

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Before we take a brief break, we wanted to share a letter we recently received from an 8 year old financial savant.  Apparently 8 year olds have always asked the tough questions (see another famous example).

Dear AllAboutAlpha.com:

I am 8 years old and just lost my allowance in a giant Ponzi scheme. Some of my little friends say there is no hedge fund alpha. Papa says, “If you see it on AllAboutAlpha.com, it’s so.”

Please tell me the truth, is there hedge fund alpha?

- Virginia Jones

Virginia, your little friends are wrong.

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Despite increased due diligence, particularly on the operations front, and a lot more tire kicking, sizing up and in many cases just saying no, money is flowing back into hedge funds’ coffers. Where it’s flowing, though, isn’t to emerging hedge fund managers or start-ups, or even to funds with less than $1 billion in assets under management (AUM).

According to a report released this month by Barclays Capital’s prime services division, some $150 billion in cool cash flowed into the hedge fund industry in the first nine months of the year, mostly to mid- and large-sized funds with assets of $5 billion to $10 billion and more.  Managers of mid-sized funds in particular – those in the $5 billion to $10 billion AUM camp – reported that year-to-date inflows actually outpaced outflows, resulting in net positive flows of approximately 5%.

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A common occurrence in the hedge fund-a-go-go days of yore was daily headlines announcing yet another prop desk trader or mutual fund manager “hanging their own shingle” to set up a hedge fund shop or join one. A look at this oldie but goodie by New York Magazine’s Steve Fishman published in May 2005 is case in point.

Beyond lucrative returns, more lucrative potential compensation and the chance to tout being a “hedge fund manager” at the local nightclub, the basic premise for most breaking out on their own was the freedom and flexibility of being the higher up, and not having to bow to one.

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Here’s a stocking stuffer for you.  Just in time for Christmas, the ECB has released its semi-annual Financial Stability Review.  According to the Bank, the world may not actually be coming to an end.  In fact, Santa seems to be about to reward mega-financial institutions.

Writes the ECB:

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If there’s one party investors are truly pining to get into this holiday season, it’s the counterparty. And if there’s a cool cat on the block that they’re hoping to hook up with to get them past the velvet rope, it’s the third-party risk management firm that can either provide them with the right tools to size up their counterparties or even do it for them.

According to a report published this week by research firm TABB Group, investors, particularly buy-side traders that work for them, are putting counterparty risk and managing enterprise risk at the top of their priority list for 2010.

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By: Steve Deutsch, AllAboutAlpha.com Editorial Board

In September, the Institutional Limited Partners Association (ILPA) rolled out its “Private Equity Principles.” This document has been getting a lot of attention and is described by the organization as…

“…a set of principles and best practices for the private equity industry with the goal of strengthening the long-term viability of the asset class as an institutional investment strategy.”

Both the means and the message are worth taking a closer look.

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You got to know when to hold ‘em, know when to fold ‘em,
Know when to walk away and know when to run.
You never count your money when you’re sittin’ at the table.
There’ll be time enough for countin’ when the dealin’s done.

As we’ve reported recently, hedge fund managers have been betting on continuing market updrafts.  But as financial historian Kenny Rogers warns us, managers shouldn’t count their winnings until the dealin’s done.  This is the subtle message in a recent BofA/Merrill Lynch report on hedge fund long positions (called, subtly, “The quarterly hedge fund “hold ‘em and fold ‘em report“).

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The past few weeks have seen an abundance of media reports about the growth of the hedge fund industry since it hit bottom earlier this year.   Not only did hedge fund launches outpace closures in Q3, but overall assets have (re-) hit the $2 trillion mark.

So what gives in the Eurozone?

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Apparently it’s not just hedge funds that are now being held to a much higher standard when it comes to demands for transparency by institutional investors.

According to a recent survey published by SEI (downloadable with free registration here), financial advisors and other investors, private equity (PE) shops are also under increasing pressure to provide higher quality reporting and more “look-through” ability to their existing and potential investors.

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McKinsey & Company, the venerable consultancy, has a thing with geese.  In 2003, the firm published a report on the then-recovering asset management industry called “Will the goose keep laying golden eggs? (October 2003)“  Then, last month, it produced another report on the beaten-up asset management sector asking the same question “Will the goose keep laying golden eggs? (October 2009).”

Who is this mythical goose and what has bestowed it with powers of prognostication not seen since Punxsutawney Phil cornered the market on predicting the onset of spring?

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