Hedge Funds Suffered Mightily in 2008

January 21, 2009 (PLANSPONSOR.com) - The Morningstar 1000 Hedge Fund Index lost 10.3% in the fourth quarter of 2008 and 22.2% for the year, wiping out the last two years of gains.

A Morningstar news release said the index bounced back slightly after extreme market illiquidity and volatility in January and March of 2008, but hedge funds have been on a steady decline since May. Massive losses in September and October of 7.9% and 9.8%, respectively, quashed any hope of salvaging the year, even though it ended on a positive note since December posted a 2.1% gain, Morningstar said.

The Morningstar with MSCI Asset Weighted Hedge Fund Composite index, which hedges U.S. dollar exposure, lost 12.9% in 2008, while the equally weighted version lost 16.4%, reflecting the poorer performance of the smaller funds.

According to the Morningstar release, investors generally lost their appetite for hedge funds in 2008, as the vehicles intended to deliver absolute returns were forced to resort to relative claims of success.

“In 2008, hedge fund managers generally failed to deliver,” said Morningstar Hedge Fund Analyst Nadia Papagiannis, in the news release. “The average hedge fund may have lost less than the stock market, thanks in part to large cash allocations, but this level of performance was not why investors agreed to pay 2% management fees and 20% performance fees.`

Asset Redemptions

Morningstar said investors “redeemed assets aggressively” in 2008.

Hedge fund inflows peaked in June 2007 and bottomed in October 2008 when more than $21 billion left the industry. In November 2008, another $19.4 billion flowed out of hedge funds, setting the year-to-date outflows at more than $44 billion.

The company said the number of funds dropping out of Morningstar`s database increased more than 150% in 2008 from 2007 ק,158 single-manager funds and 490 funds of funds were removed in 2008 compared with 434 single-manager funds and 208 funds of funds in 2007.

Emerging market equities proved to be the worst strategy in 2008. Although emerging markets bounced back in December, the MSCI Emerging Markets Index lost almost 55% in 2008, while the Morningstar Emerging Market Equity Hedge Fund Index lost 45.6% in 2008 and 20.7% in the last quarter alone.

Convertible arbitrage funds took a big hit in 2008. The Morningstar Convertible Arbitrage Hedge Fund Index dropped 13.1% over the quarter and 24.9% over the year,” Morningstar said.

More information is available  here .