Hedge funds gained 7.8 percent on the average last year, according to UBS Hedge Fund Monthly Update. The best performing strategy was Credit, up by 10.4 percent last year, with mortgage and structured credit hedge funds outperforming the most, as you will notice in our list of the Top 30 Hedge Funds of 2012. Notably, EM focused funds returned 9.1 percent, followed closely by Asia focused hedge funds, which returned 8.9 percent.

HFRI and Market Indices

Both UBS and JP Morgan Chase & Co. (NYSE:JPM)’s analysis noted an outperformance in Europe and Asia in the last month of 2012, which was supported by positive investor sentiment. The largest gainers at the year’s end was the Chinese equity market index CSI 300 Index (SHA:000300), which rose 17.9 percent in a single month, while Japan’s NIKKEI 225 (INDEXNIKKEI:NI225)  rose 10 percent.

The most notable turning point of the year was Mario Draghi’s “whatever it takes” speech, which eventually led to a rejuventaion of equity markets. After this reassuring statement, the MSCI World Index appreciated 13 percent through the end of 2012. In the hedge fund world, UBS notes that the top winners were those who bet on an ECB led recovery in the eurozone, whilst those who bet against the union, were the biggest losers. The most vulnerable strategies were macro, equity and event-driven.

MSCI World Sector Performance

In equity, the highest gaining sectors were Materials and Finance, while Telecom and Consumer Staples detracted the most. The overall Hedged Equity was up 9.1 percent and investors’ outlook for the sector this year is positive. UBS reports that the correlations are down, so its forecasts are optimistic. However, BAML pointed out that the equity market will undergo a correction in the first half of 2013, because of a strong correlation with Eurodollar positioning. In equities, the largest short exposure was concentrated on Intel Corporation (NASDAQ:INTC), salesforce.com, inc. (NYSE:CRM), Verizon Communications Inc. (NYSE:VZ), International Business Machines Corp. (NYSE:IBM), Priceline.com Inc (NASDAQ:PCLN), Research In Motion Limited (NASDAQ:RIMM) (TSE:RIM), General Motors Company (NYSE:GM), Seagate Technology PLC (NASDAQ:STX), Gilead Sciences, Inc. (NASDAQ:GILD) and Virgin Media Inc. (NASDAQ:VMED), at the year’s end.

Short spikes in short interest were seen in Herbalife Ltd. (NYSE:HLF) (FRA:HOO) from Bill Ackman’s very publicized position. Other short bets included, Garmin Ltd. (NASDAQ:GRMN), Safeway Inc. (NYSE:SWY), Uni-Pixel and SandRidge Energy.

Last year saw the largest inflows in ETFs, amounting to $188 billion. Hedge funds mostly covered their positions in SPDR S&P 500 ETF Trust (NYSEARCA:SPY), iShares Russell 2000 Index (ETF) (NYSEARCA:IWM), iShares MSCI Brazil Index (ETF) (NYSEARCA:EWZ) and SPDR S&P Oil & Gas Explore & Prod. (ETF) (NYSEARCA:XOP). Whereas signinficant short exposure was increased in Materials Select Sector SPDR (NYSEARCA:XLB), SPDR S&P Retail (ETF) (NYSEARCA:XRT), Market Vectors Gold Miners ETF (NYSEARCA:GDX) and iShares FTSE/Xinhua China 25 Index (ETF) (NYSEARCA:FXI).

Event Driven strategy, up 8.1 percent in 2012, gained from CNOOC Limited (NYSE:CEO) (HKG:0883)’s acquisition of Nexen Inc. (NYSE:NXY) (TSE:NXY), PETRONAS DAGANGAN (PINK:PNADF)’s acquisiton of Progress Energy Resources and the Greek government debt. Other big deals of last year were, Glencore International Plc (LON:GLEN)’s acquisition Xstrata PLC (LON:XTA), Softbank Corp (TYO:9984) buying Sprint Nextel Corporation (NYSE:S), MetroPCS Communications Inc (NYSE:PCS) acquiring T-Mobile and Rosneft’ NK OAO (MCX:ROSN)’s acquisition of TNK-BP.

Event managers were also assisted by Sprint Nextel Corporation (NYSE:S) and Clearwire Corporation (NASDAQ:CLWR)’s expected deal,  IntercontinentalExchange Inc (NYSE:ICE) and NYSE Euronext (NYSE:NYX) merger and also Knight Capital Group Inc. (NYSE:KCG) and Getco announcements. Both JPM and UBS reports forecast this year to be an acqusition-spree, where many new mergers and spinoffs will take place.

In event-driven security lending, important movers were Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) plan to buy Mcmoran Exploration Co (NYSE:MMR) and Plains Exploration & Production Company (NYSE:PXP). NRG Energy Inc (NYSE:NRG) finalized merger with Genon Energy Inc (NYSE:GEN). Precision Castparts Corp. (NYSE:PCP)  taking controlling stake in Titanium Metals Corp (NYSE:TIE), and also Eaton Corp finalized acquisition of Cooper Industries PLC.

Going forward, investors lost interest in CTAs’ Global Macro, while preferring Long Short, Credit and Event Driven strategy.