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In the last bear market after the popping of the tech bubble, hedge funds held their own and exhibited positive and uncorrelated returns to other asset classes. This time, hedge fund returns have been far more correlated with equities.

A recent NY Times article states that HFR reports that the average hedge fund is down 4% YTD. Other figures available to me show YTD returns to be closer to 5%. The negative returns are not just attributable to the positive correlations to the S&P 500. The credit crunch has hit hedge funds too as prime brokers reduce risk:

It is now 5 to 10 percent more expensive for hedge funds to borrow from banks than it was a year ago, and banks are increasingly hesitant to lend to hedge funds for long periods.

Investor reactions have been predictable:

"I think we’re seeing what these hedge fund managers really, truly are,” said Robert Discolo, head of hedge fund strategies for A.I.G. Investments, an asset manager within the insurance giant A.I.G. (NYSE:AIG) “And some of them really can’t make money in a difficult environment."

In reaction, some hedge funds are reported to be reducing leverage. Others are cutting fees (subscription required) to try and retain assets.

The shakeout is truly in progress. It remains to be seen how the hedge fund business model survives.

Disclosure: None

Source: Hedge Funds: The Shakeout Is in Progress