Once-invincible hedge funds brace for bad 2009

But not now. Hedge funds' assets hit an all-time peak of $1.93 trillion in June but have since fallen to $1.56 trillion, according to Hedge Fund Research. The steep declines mean that most portfolio managers will be taking much smaller paydays in 2009.

Still, not every hedge fund lost money last year.

Chris Wang, founder and portfolio manager of New York-based SYW Capital Management, enjoyed a sizzling 2008 managing $52 million in assets. Using a strategy of "short-selling," or betting that stocks will fall, he managed a return of 80 percent. Wang, 36, said his fund "became ultra-bearish" once the scope of the credit crisis became clear.

"We could see the world coming to an end before our very eyes," Wang said.

Unnerved by losses, many hedge fund investors want their money back. Investors yanked $40 billion out of hedge funds in October, according to Hedge Fund Research.

Those who got their money out were the lucky ones. In recent weeks, dozens of hedge funds have imposed "gates" keeping investors from withdrawing their money, fearing a run on their assets that could drive them out of business.

As troubled funds throw up the gates, investors have little choice but to pull money from healthier funds, which then are forced to sell assets to raise cash.

"It's disappointing," said Robert Romero, manager at Palo Alto, Calif.-based Connective Capital, a $120 million hedge fund that delivered a 3.5 percent return in 2008. He said he expects to lose about 20 percent of his capital from redemptions.

Hedge fund investors are also grappling with the still unknown toll of Madoff's alleged Ponzi scheme, which authorities say bilked investors of billions of dollars. Among the largest victims were investors in "funds of funds" — capital pools that invested across a number of hedge funds, supposedly limiting risks.

Many funds of funds that were wiped out with Madoff have come under fire for not adequately vetting his trading strategy and for failing to diversify investors' assets. Several have written to frantic investors to reassure them that they're closely monitoring their investments, said Nadia Papagiannis, an analyst at Morningstar.

For many funds of funds, it's too late. There were 3,660 funds of funds listed in Morningstar's database at the end of 2008, a drop of about 12 percent from the previous year.

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Fewer funds of funds mean fewer dollars flowing into traditional hedge funds. That will make it harder for many hedge funds to stay afloat in 2009. Barclays Capital strategist Robert McAdie has said that 70 to 80 percent of hedge funds could disappear this year.

Those that survive are likely to undergo sweeping changes, including lower fees charged to investors and a more back-to-basics investment philosophy that will lead to smaller annual returns.

But just because there will be fewer hedge funds and smaller rewards doesn't necessarily mean the high-stakes hedge fund culture will disappear, said Sol Waksman, president of Barclay Hedge Ltd., a Fairfield, Iowa-based research firm.

"Right now, fear is in the driver's seat," he said. "At some point, greed will return."

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