Hedge funds had their best year last year since 1999, according to the Hennessee Group, a hedge fund advisory firm.

The Hennessee Hedge Fund Index gained 24.6% in 2009. Equity indices also gained in 2009, with the S&P 500 up 24.7%, the Dow Jones Industrial Average up 18.8%, and the Nasdaq Composite Index gaining 43.9%. In 1999, the Hennessee Hedge Fund Index was up 30.78%.

“Hedge funds competed very well with the stock market, with a lot less risk. Whenever you can achieve market returns with a third less risk, that is professional money management, as opposed to the traditional money managers who are long-only and who achieve market returns with 100% net exposure,” said Charles Gradante, managing principal of the Hennessee Group. “I don’t expect the market to do 24% next year. I don’t expect hedge funds to do 24% next year. I expect the market to do 8%. I expect hedge funds to do 12%, 12.5%.”

Leading the way in 2009 were convertible arbitrage and distressed strategy funds. The Hennessee Convertible Arbitrage Index rose 39.9%, its best year since the group created the index in 1993. Convertible bond funds benefited from elevated levels of volatility and a significant contraction in credit spreads throughout the year, according to the Hennessee Group. The Barclays Aggregate Bond Index gained 5.9% in 2009, and the Merrill Lynch High Yield Master II Index was up 57.5%.

The Hennessee Distressed Index rose 43.3% for the year as distressed funds benefited from long bias and contraction in credit spreads, and the Hennessee Arbitrage/Event Driven Index gained 30.1% in 2009, pushed higher by convertible arbitrage and distressed.

“As 2009 unfolded, it became clear the economic armageddon was not going to occur. Credit spreads narrowed between junk bonds and Treasuries. In 2008 when the wall of worry was at its height, distressed and converts were hit worst. When the market came back, when it became clear the Fed activities and government bailouts were going to forestall the fallout, people were more comfortable taking risk. There was an immense appetite for yield,” Gradante said

While the Hennessee Long/Short Equity Index gained 21.7% in 2009, short-biased funds posted the steepest declines among strategies in 2009 as the Hennessee Short Biased Index lost 17.5%.

In 2009, even the weaker cheaper stocks rose with the tide, and short-bias managers suffered, Gradante said. In 2010, hedge funds, relying heavily on research, will benefit from a return to a focus on fundamentals in the broader markets.

The Hennessee Hedge Fund Index is comprised of more than 1,000 hedge funds with at least $10 million in assets under management and 12-month track records that report their performances, net of fees, to Hennessee.