Investors are always on the look-out for the next great manager, though the top league of large hedge funds has not changed much in years and consists mostly of the same names. One firm that received attention from large investors last year was Dallas-based Carlson Capital, the manager of the Black Diamond group of hedge funds.

A major fund of funds put money into Double Black Diamond, a relative value and event arbitrage fund with a one-year lock-up.

Clint Carlson started the firm in 1993 and in 1997 launched Double Black Diamond, which came to be known for its solid long-term track record, including relatively strong performance in 2009. The firm expanded its investment staff during the crisis. How a manager did in 2008-2009 has become a touchstone for investors.

Some big trades have gone badly.  Earlier this month a Carlson portfolio manager, Vikas Lunia, wrote a letter to Information Services Group demanding changes to boost the stock. Carlson owns 9% of ISG, having bought the company starting at its IPO five years ago. Since then the value of the initial investment dropped 87%.

Carlson total assets across several strategies and funds was $6 billion as of early 2011, according to a post on SeekingAlpha.com.   Mr. Carlson’s expertise is risk arbitrage but the firm expanded into new strategies. HedgeFundAlert reported in November 2011 that a global macro fund was added to the Black Diamond group.

Among the better-placed fund of funds operators is Permal Group, which has a solid track record going back to the 1970s and access to the marketing network and other capabilities of its parent, $612 billion asset manager Legg Mason.

Still, Permal’s total assets continued to shrink due to losses in underlying hedge funds and redemptions over time. As of the end of September 2011, total assets under management were $20.7 billion.  That is down from $25 billion two years ago and $35 billion pre-crisis.

Last June the Wall Street Journal reported that Citigroup’s private bank and Morgan Stanley Smith Barney warned investors about two Permal funds should a market crunch occur. The concern was whether the funds’ liquidity would be sufficient if a large number of redemptions came at once. Permal denied liquidity problems. Worries about fund of funds’ liquidity go back to 2008.

In one respect Permal proved itself in 2009—unlike many funds of funds, it had not invested with Bernard Madoff. Despite pressure from clients who favored Madoff, Permal decided not to invest after investigations raised questions about his strategy.

That and other advantages help against the headwinds faced by funds of funds.  Permal is introducing new products via Legg Mason and last year acquired new institutional clients such as New York City pensions.

Do alternative investments, primarily private equity and hedge funds, have a future at investment banks? The impact of new regulation is not yet fully observable. So far, Goldman Sachs and JP Morgan Chase present different pictures.

Goldman’s alternative assets under management continue to shrink and are down 4% from December 2010, to $142 billion. This is a factor in declining incentive fee revenue, which in turn is a factor in declining overall revenue.

JP Morgan’s alternative assets went up 5% from December 2010, to $113 billion.  There’s growth, though stalled in the fourth quarter and slow in general. Highbridge Capital, the bank’s  $26.6 billion hedge fund business, is reportedly trying to raise $3 billion for a second mezzanine fund.

If you consider the two banks over time, Goldman was more active in alternatives than JP Morgan and still runs a greater amount of alternative assets, but it looks like trending down. Then again, Goldman chief financial officer David Viniar argues that most of the current changes are cyclical, not a secular trend, and will reverse as the cycle turns.

As for new regulation, the Volcker Rule of the Dodd-Frank Act should have greater effect on JP Morgan, a depository institution that is in theory subject to the restriction on hedge fund and private ownership and prop trading, than on Goldman, not a depository institution. But the structure of a company matters. Besides, regulators are still working in how to implement the rule.

Rates are so low, the only direction they can go is up. That’s the conventional wisdom and it implies that the bond rally is near its end.  Despite that concern, investors have been moving money to fixed income arbitrage funds. The reason is that these funds, unlike long-only bond investments,  typically do not bet on market direction.  Hence rising rates are not likely to squash their return.

In 2011 fixed income arbitrage made 4.7%, as measured  by the Dow Jones Credit Suisse Broad Index. While that looks puny compared to the 7.8% return on Barclays Aggregate Bond Index, arbitrage is not as vulnerable to market shifts compared to long-only bonds.

In any event, most investors are not buying an index; they’re buying specific managers. Within the fixed income arbitrage field are funds that did much better than the group.

One that I noticed is Cranwood Fixed Income Arbitrage Fund, up 17.7% for the year. Cranwood’s strategy is to identify short-term discrepancies on the US Treasury yield curve and use futures contracts for Treasury notes and bonds to trade on the spreads. Cumulative return since inception in 2008 is over 62%.

Hedge funds as a whole lost money in 2011. Fixed income arbitrage was one of the best performing strategies. It has not been a popular strategy in the past but received inflows of $18 billion in the past 12 months according to Barclay Hedge.

German national output declined in the fourth quarter.  If the recession caused by the European debt crisis spreads and engulfs the world economy, a crisis situation like 2008-2009 could again develop, with all markets going downhill together. What type of investment will perform in this worst-case scenario?  

According to a report based on the views of BlackRock portfolio managers, alternatives offer protection for long-term investors if the underlying investment can withstand a deep recession, short-term funding crunch or regulatory crackdown.

For hedge funds, this means managers that can survive mass redemptions, a sudden cut-off in credit and regulators’ bans on short-selling—all the adverse events that occurred in 2008-2009.  That could be funds in liquid strategies that do not rely on credit.

A second condition necessary  for successful crisis investing is to have long-term staying power; not to have to sell when prices plunge and ratings drop. In addition the BlackRock report emphasizes “how important it is to pick the right manager in alternative investing.” Indeed, the performance dispersion among managers is wider than ever, so that investors in the same strategy can make money or lose money depending on the manager they’ve chosen.

Not that BlackRock presents global recession – the report calls it Nemesis after the Greek goddess who punishes hubris – as likely. Chief equity strategist Bob Doll says the US economy will likely muddle through 2012, with growth constrained by continuing de-levering but still positive.

However, the advice is to hold some cash in case Nemesis happens, whether because of the European situation or other possible triggers. The BlackRock report mentions for instance a growth shock in China due to bad policy moves or an Israeli strike on Iran’s nuclear facilities that causes oil prices to hit $150 a barrel.

Cash gives you protection in a liquidity crisis but also the wherewithal to take advantage of buying opportunities. As BlackRock points out, stocks, junk bonds and natural resources were great buys in early 2009. The hedge funds and investors that were able to buy then and hold on did well.

Funds based on the strategy may get the return on certain investments via swaps or other derivatives rather than investing with a manager.

The director of the program is Nancy Everett, who used to be chief investment officer at the Virginia Retirement System, where she helped build a sophisticated hedge fund portfolio. Subsequently she moved to another large pension manager, General Motors Asset Management, in 2005.  She joined BlackRock in 2011.

The strategy is meant to be turnkey solution for investors that want a variety of alternatives and a way of taking advantage of opportunities as these arise. Early in 2011 BlackRock chief executive Laurence Fink said that investors favor go-anywhere approaches where managers can move swiftly from one market to another.

Global macro is the kind of flexible strategy that should do well in a difficult economic environment. How did investors in the strategy do in 2011? It depends, is the answer. If they picked the right manager, they made a fabulous 30% or more gain for the year. They picked the wrong one, they lost a lot of money.

The spread across managers is so wide that macro strategy indexes tell divergent stories. BarclayHedge reports an almost flat positive 0.36% return through December, but many funds have not yet sent their numbers to the database. The main Hedge Fund Research macro index shows a 3.5% loss through November.

By contrast, the Dow Jones Credit Suisse macro index is up almost 6% through November. That is the broad benchmark. The Dow Jones Credit Suisse Blue Chip index for global macro gained nearly 8% for in the same period—the Blue Chip indexes contain  funds with strong track records. Then again, yet another Dow Jones Credit Suisse macro index lost around 10% through December.

Indexes for the same strategy vary so much because they’re based on data from different funds and the funds’ performance is all over the place.

Hedge fund returns always tend to deviate more than mutual funds returns, in large part because hedge managers tend to have more distinctive approaches. Performance may be even more widely dispersed now, because managers respond differently to market uncertainty.

As a result, investors are paying more attention than ever to managers’ past experience in tough markets. What do investors want? Crisis-scarred survivors who showed themselves capable of turning volatility to account.

GeoEye offers satellite-based imaging to users that range from the US Department of  Homeland Security to oil pipeline operators. Promising though that may sound, GeoEye stock went into a downward spiral in the last quarter of 2011. Meanwhile Cerberus Capital accumulated a large position in GeoEye.

In September GeoEye was fluctuating around $35 a share. Last week it closed at about $22. The conventional wisdom is that the stock is undervalued and should recover in 2012. Presumably Cerberus chief Stephen Feinberg agrees with that assessment.

Over several months Cerberus funds bought the stock at prices that vary from a high of $44 – double the current price – to $21. In December alone the funds bought some 550,000 shares.

On the whole the trade must be losing money so far but Cerberus has been known to hold positions for years. In this case it is not clear what would trigger the recovery but there are possibilities.

GeoEye is recognized as a technological leader in its area; the question is the extent of the market for the product. Mr. Feinberg must believe that the company will be able to get contracts with government and business clients. If it does, then Cerberus will notch a win. But what if it doesn’t?

John Paulson’s funds are among the worst performers of 2011. Even a conservative version of his event-driven strategy lost more than 40% this year.  Many of the losing positions were in financials, a result of  Paulson & Co.’s bullish macro gamble on a strong recovery—which of course was upset by the European debt crisis.

But not every financial trade worked against Mr. Paulson. American Capital is an interesting bet that appears to have made money. Paulson funds bought a 13% stake in the company in April 2010, at $5.06 per share.  American Capital is a publicly-traded private equity manager.

Paulson has sold most of the shares. The selling price was $10.14 in July, it declined to $6.42 in October but partially recovered last week, when the funds unloaded the shares at  $7.16 to $7.15. Today the price was below that, fluctuating around $7. So Paulson did well to sell and made money on all the sales.

What accounts for the success of this one financial trade? American Capital had a net loss of $464 million in the third quarter and its net asset value per share went down 9%. The stock remains under pressure. But Paulson bought at a low price and sold at the right times.

Was this due to strong research or was it just luck?  The jury is out.

New York Life is said to have a new fund of funds in the works. The goal is to find managers who’ve made strong returns over multiple market cycles, in particular those with a proven ability to do well at times when stocks and bonds are going down.

New York Life retained Private Advisors to make investment decisions and monitor the portfolio. Private Advisors was founded in 1997 by Louis Moelchert, a former investment officer of the University of Richmond endowment. The firm managed $3.5 billion in hedge fund and private equity assets as of this October.

Charles Johnson III is a partner— he was president of the US arm of EIM, Arpad Busson’s fund of funds business, before joining Mr. Moelchert in 2001.

Private Advisors wants managers with a minimum three-year track record and, like most institutional investors these days, requires portfolio funds to have an independent administrator and annual audits by a recognized accounting firm.