Hedge fund assets take biggest plunge since 2008

money black hole

The mountain of money hedge funds control is shrinking.

The hedge fund industry suffered a $95 billion decline in assets to $2.87 trillion during the turbulent third quarter, according to HFR.

That represents the first drop in hedge fund capital in three years and the biggest since just after Lehman Brothers collapsed during the 2008 financial crisis.

The declines came during a period of heavy volatility on Wall Street that was triggered by fears over China's economy and uncertainty about Federal Reserve policy. Clearly, hedge funds were not immune to the violence in financial markets.

"It was primarily performance driven. We saw poor performance from a few specific segments of the market drag down assets," said Peter Laurelli, global head of research at investment data and analytics firm eVestment.

The lackluster performance spooked at least some investors. They yanked $42 billion from hedge funds during the third quarter, according to HFR. That was only barely offset by inflows of $48 billion during the period.

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Hedge fund world is getting crowded

All of this is the latest sign of the trouble facing the increasingly-crowded hedge fund world. Not only are more hedge funds battling each other for the best investment ideas, but there are fewer opportunities out there to jump on. The amount of available alpha -- risk-adjusted returns over a given benchmark -- has declined by about half over the last two decades, according to Point72 Asset Management.

"The cost of being excellent in the industry keeps going up," Doug Haynes, president of Point72, said over the weekend on "Wall Street Week." "This is an industry that 10 or 15 years ago had very little barriers to entry. There are a lot now."

Point72 was created when hedge fund titan SAC Capital was forced to stop accepting external money as a result of an insider-trading scandal.

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At least hedge funds beat the stock market

Hedge funds have been dogged by years of disappointing performance. They also face a competitive threat from cheaper alternatives, including exchange-traded funds, or ETFs.

While hedge funds lost money during the third quarter, they were hardly alone. In fact, the hedge fund industry actually outperformed the stock market as a whole.

The HFRI Fund Weighted Composite Index fell by nearly 4% last quarter, compared with a 7% slump for the S&P 500.

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Brazil burns macro hedge funds

But certain pockets of the hedge fund world took it on the chin last quarter.

Macro hedge funds posted losses amid heavy volatility in emerging markets. These funds calibrate their investing strategy around big-picture economic and political bets.

The biggest macro casualty was billionaire hedge fund manager Michael Novogratz, who lost $100 million from bad bets in Brazil and September. Novogratz announced earlier this month he is pulling the plug on his money-losing hedge fund at Fortress Investment Group (FIG) and leaving the firm by the end of the year.

Related: America's 'smart money' is getting burned in Brazil

Glencore, Valeant bets backfire

Event-driven hedge funds, which try to capitalize on opportunities created by major events like mergers and bankruptcies, suffered sharp performance losses.

HFR said the losses were at least partially sparked by widely-held positions in hedge fund favorites like Glencore (GLCNF). The mining and trading company's shares plummeted 63% last quarter over fears about its ability to survive China's slowdown and crashing commodity prices.

Another darling of the hedge fund world has been Valeant (VRX), the embattled drug maker that has billionaire Bill Ackman as one of its biggest supporters. Valeant shares plunged 20% last quarter due to scrutiny over its aggressive pricing tactics. The stocks has tumbled further this quarter in the wake of allegations of Enron-like fraud from a short seller.

CNNMoney's Patrick Gillespie contributed to this report.

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