This chart shows losses in the Standard & Poor’s 500 index since October 2007. Joseph Brusuelas, a director at Moody’s Economy.com, said from the 2007 peak to the first quarter of 2009, U.S. stock holdings fell $7.6 trillion in real terms. “Our estimate suggests that through the end of March, U.S. stock wealth will have fallen by $66,000 per household,” he said.

- Emily Kaiser

Wealth managers at Citi Private Bank are telling their clients to stay neutral in their exposure to hedge funds at the moment, whether the strategy be event driven, equity long/short or macro. The main reason is that capital markets are still stressed and many hedge funds still need to deleverage.

The firm points out, however, that hedge funds had a good news-bad news kind of year in 2008. Based on the HFRX Global Hedge Fund Index, it was the worst performance on record. The index lost 23.3 percent. Its next worst performance was 2002 — and that was only a 1.5 percent decline.

Losses were widespread across all kinds of strategies. Only merger arbitrage and systematic macro gained anything. 

The good news, so to speak, was that that this dreadful performance was better than what you would have got from just plain equities. The S&P 500, for example, lost 38.5 percent, meaning that the hedge fund index outperformed by a whopping 15.2 percentage points.

It was that kind of year.

How bad will hedge funds’ year-end performance figures look?

According to Credit Suisse/Tremont, funds fell 6.30 percent in October after a 6.55 percent drop in September, taking losses for the first ten months to 15.54 percent.

Seven strategies are now nursing double-digit losses, with only two — managed futures and dedicated short bias — in positive territory.

Even global macro, which bets on the likes of global equity markets, world currencies, sovereign debt and commodities, is now back in the red. These funds are down 7.10 percent after substantial losses in September and October.

Many investors who have not already pulled out their money will be keenly watching year-end figures as they review their portfolios.

The last time hedge funds lost money over a calendar year, according to Hedge Fund Research, was in 2002 when they fell 1.45 percent.

The questions for hedge funds are how bad will it look in 2008, and will it be any better in 2009?

So star hedge fund manager Greg Coffey has opted to join established firm Moore Capital.

In April, when high-performing, high-earning Coffey resigned from GLG, the market was awash with rumours that he wanted to start up his own firm, pulling in billions from investors.

However, times have changed in the hedge fund industry.

The average fund is down nearly 20 percent so far this year, according to Hedge Fund Research’s HFRX index, while emerging markets funds have taken a particular battering as markets such as Russia and China have fallen.

Fund of funds managers say that top funds that were once able to turn investors away are now open again as investors across the industry withdraw their assets.

So perhaps for Coffey, who forfeited a bonus reportedly worth around $250 million when he resigned from GLG, a start-up has just become too risky for now.

If the shrinkage of the hedge fund industry is giving someone as well-regarded as Coffey reason to think again, then for those without a strong track record times could be very tough indeed.

In these troubled times, go back to basics.

Theo Zemek, AXA Investment Managers‘ global head of fixed income, says investors should adopt “Quaker investment policies” – sober and safe investment strategies that can be explained to their grandmothers.

“Anyone who utters the word ‘hedge’, after all these CDS (failures), ought to be taken out and be shot,” the 25-year markets veteran told a media briefing.

“This is the scariest market I’ve ever seen in 25 years. The world of complex instruments, credit guarantees… That world is very much an ancient history… It’s a darn tough market. Who is left standing among our counterparties?”

Zemek said she overheard commuters on the train discussing the new preference for simplicity in investment strategy and citing Goldman Sach’s chief global economist Jim O’Neill as saying: “Anyone who thinks they understand what’s going on is guaranteed to be an idiot.”

AXA IM’s parent company AXA said last week that it has a non-material equity interest and credit exposure in Lehman Brothers (collapsed) and AIG (bailed out).

More stress on its balance sheets is just about the last thing that the banking sector needs. The subprime mortgage crisis has already battered banks, leading to huge losses, scrambles for funding and free-falling banking shares. The S&P index of financial stocks has lost more than 30 percent so far this year. At its worst, the index plunged around 55 percent between a high in May last year and a low in June this year.

Now, after a brief respite, comes more bad news. First, hedge funds still seem to be wedded to betting on further losses. Laurence Fletcher, who writes about hedge funds here at Reuters, notes that more than 6 percent of British banks’ equity is on loan to short sellers.

More worrying yet for banks, however, may be their exposure to embattled Fannie Mae and Freddie Mac. In a report, Societe Generale economists estimate that U.S. commercial banks hold about $1 trillion in Fannie and Freddie debt. That amounts to a whopping 9 percent of the commercial banks’ balance sheets.

Then again, maybe the danger to the banks will simply add pressure on the U.S. government for make sure Fannie and Freddie don’t fail.

Things are going from bad to worse for hedge funds.

Having only just clawed back their losses after a dreadful March, the closely-watched Credit Suisse/Tremont Hedge Fund Index shows hedge funds lost a hefty 2.61 percent in July after being hit by a double-whammy of market movements.

These freewheeling funds had been betting for some time that banks stocks would fall as the credit crisis ate into their profits, while also betting that commodities would rise as demand for oil, metals and food soared.

This had been working well, but in July banks bounced back because they looked so cheap to some investors, while commodities fell from some of the dizzying heights they had recently reached.

To make matters worse, anecdotal evidence suggests some managers had only recently put these bets on. Having watched them work for months and months and eyed the lucrative returns from a distance, they almost immediately saw them turn sour.

This all means that for the first seven months of the year the industry is down 2.11 percent and could even end the year in negative territory.

If this happens, more investors may reassess why they are putting their money with funds that are supposed to be able to make money in all market conditions – yet can’t deliver.