HEDGE funds lost 18.3 per cent in 2008, their worst year on record, as managers misjudged the severity of the financial crisis.
A gain of 0.42 per cent in December lessened the average loss for the full year, according to Hedge Fund Research Inc's Fund Weighted Composite Index. The decline was the largest since the Chicago-based firm began tracking data in 1990.
"Hedge funds failed to appreciate the magnitude, breadth and duration of the declines we saw across most markets," said Michael Rosen, principal at Angeles Investment Advisors in Santa Monica.
Investment losses and client withdrawals reduced industry assets to $US1.1 trillion ($1.5 trillion) last month from a peak of $US1.9 trillion in June, Morgan Stanley reported.
Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested.
The decline by hedge funds last year compared with the 37 per cent drop in the Standard & Poor's 500 Index, including reinvested dividends, the benchmark's worst showing since 1937.
Commodities slumped 33 per cent, the UBS Bloomberg Constant Maturity Commodity Index of 26 contracts showed. The worst previous performance by hedge funds was in 2002, when they lost 1.45 per cent, while the S&P 500 tumbled 23 per cent.
Among the main investment strategies, equity hedge funds lost the most last year, an average of 26 per cent, Hedge Fund Research said. Event-driven funds, which invest in companies going through changes such as mergers and spin-offs, lost 21 per cent. Macro hedge funds, which can bet on securities from commodities and interest rates, returned 5.7 per cent.
Managed futures funds, which rely on computers to decide when to buy and sell securities, outperformed peers last year after betting against stockmarkets and correctly betting on the direction of commodities.
Banks restricted the amount of money they lent to hedge funds as credit markets froze, while funds cut investments and held cash to avoid losses. Funds held more than $US300 billion in cash, Man Group in London reported in December.
RAB Capital, based in London, and GLG Partners of New York were hurt when some of their assets held in the European brokerage arm of Lehman Brothers were frozen after the New York-based investment bank filed for bankruptcy in September. The Lehman division provided lending and brokerage services to hedge funds.
Market losses in the second half of the year led funds to limit investor withdrawals. Funds that invest in hedge funds lost 20 per cent last year, Hedge Fund Research said.
The industry was also hit by the alleged fraud by Bernard Madoff, who last month told employees that his investment company was "a giant Ponzi scheme" that may have cost clients as much as $US50 billion.
About 6.9 per cent of the industry, or 693 funds, closed in the first nine months of last year, Hedge Fund Research said. For the whole year, 920 funds may have been shut, topping the all-time high of 848 closures in 2005, the firm said.
Bloomberg
