UPDATE: Hedge Funds Gain 0.3%-0.8% In January, Trail S&P 500

Hedge funds posted additional gains in January, though the industry underperformed the broader U.S. stock market for the second straight month.

The Hennessee Hedge Fund Index, compiled by hedge-fund adviser Hennessee Group LLC, edged up 0.8% in January; another widely followed index, Hedge Fund Research's HFRI Fund Weighted Composite Index, gained 0.29%. The Standard & Poor's 500 rose 2.3% during the period.

"A combination of civil unrest in Egypt and higher reserve requirements at Chinese banks contributed to weakness across Asian and Middle East equity markets," holding back gains in many index funds, said Ken Heinz, president of Hedge Fund Research.

While hedge funds' January performance also trailed the 2.7% advance of the Dow Jones Industrial Average for the period, Hennessee said it was still a "decent start to the year."

"The general consensus among hedge-fund managers is that the economy is improving and markets should continue to advance in the short term," Hennessee co-founder Charles Gradante said. "That said, managers are aware of several key macro risks, such as the European sovereign debt crisis, emerging-market inflation, and fiscal imbalances in the U.S., that have the potential to cause volatility throughout the year."

Hedge funds employing event-driven strategies had the most gains in January, rising 1.96%, and distressed and restructuring funds gained 1.25% with contributions from exposures across U.S., European and global emerging markets, Hedge Fund Research said.

While hedge fund performance continued to lag behind the broad market, investors continued to move money to the industry. TrimTabs Investment research and BarclayHedge said funds saw their sixth straight month of inflows in December, taking in an estimated $6.6 billion.

Analysts said hedge funds have been generating returns at a low level of volatility.

"Hedge funds produced relatively better risk-adjusted returns than traditional asset classes in 2010 as managers continued to employ a diverse range of investment strategies. Overall hedge funds posted returns on par with global equities with nearly a quarter of the risk," according to the 2010 Hedge Fund Industry Review conducted by Credit Suisse and Dow Jones Indexes. "This risk/return profile is unique to hedge funds, suggesting the incorporation of hedge funds into an overall portfolio allocation could provide diversification benefits." Dow Jones Indexes, an index provider best known for the Dow Jones Industrial Average, is 90% owned by CME Group Inc. (CME) and 10% by Dow Jones, which publishes this newswire.

Hedge funds posted a risk-adjusted return, as calculated in a measure called the Sharpe ratio, of 0.78 in 2010, higher than the 0.10 ratio for global equities. The higher the Sharpe ratio, the better the risk-adjusted return.

The hedge-fund industry for the most part has regained its footing since the financial crisis wiped out hundreds of billions of dollars from its asset base. HFR last month said industry assets reached $1.92 trillion at the end of December, just short of its calculation of their $1.93 trillion peak in mid-2008. TrimTabs and BarclayHedge estimated industry assets at $1.7 trillion, the highest level they estimated since October 2008.

-By Amy Or, Dow Jones Newswires; +1 212 416 3142; amy.or@dowjones.com

--Lauren Pollock contributed to this article.

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