More than two-thirds of hedge funds are below their high-water marks, the point at which they are able to charge investors performance fees, according to Credit Suisse.

The main source of income for hedge fund managers is their share of investment profits, typically 20 per cent; but if a fund drops in value, the manager must recoup past profits before charging any more performance fees.

However, after a difficult year that left more than half of all hedge funds nursing losses, Credit Suisse finds that hedge fund sentiment has started to improve from the caution that prevailed at the end of last year. “Managers have started to put some money to work,” said Philip Vasan, head of prime services for Credit Suisse.

The bank’s hedge fund clients currently have leverage of 2.5 times, meaning that the average fund has $150 of debt added to each $100 of capital, off the post-crisis low of 2.4 times, but well below the 2.8 times high.

Cash balances have also fallen from 25 per cent of assets in the summer to 22 per cent now as confidence has improved.

Yet for many funds significant trading gains or a sustained change in stock market momentum is needed. Just over a third of event funds, which seek to trade around corporate activity such as mergers, or long-short equity funds that pick stocks, are at least 10 per cent below their high-water marks.

It can be a long way back. Credit Suisse calculates that 13 per cent of hedge funds have not earned any incentive fees since at least 2007. Most of these are small funds with assets of less than $100m, which struggle to retain staff without the income available from performance fees.

Larger funds tend to have greater reserves to pay staff and hold on for a recovery. Last week Citadel, the Chicago-based hedge fund run by Ken Griffin, finally passed the high-water mark for all its investors after the group’s flagship funds plunged in value by 55 per cent in 2008.

Citadel’s Kensington and Wellington funds passed the hurdle after rising 20 per cent last year, and then adding a further 2.5 per cent in the first three weeks of January, according to a person familiar with the situation.

Such managers dealing with losses must also fight to retain assets. While the industry attracted $70bn in new capital in the first three quarters of the year, according to Hedge Fund Research, it saw very slight outflows in the final quarter as investors redistributed capital.

For instance, clients pulled $8.6bn from event and equity-driven funds in the fourth quarter, in pursuit of better performance. Macro funds, which seek to profit from broad economic trends, attracted $7.9bn, while relative value arbitrage – a strategy of seeking price differences between related securities that was one of the few not to lose investors money last year, according to HFR – took in $5.9bn.

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