Big hedge funds are getting slaughtered

NEW YORK (CNNMoney) -- In a global market roiled by uncertainty, there's one bet that's becoming increasingly likely: several big hedge funds will face steep losses before the year is through.

There's no way for retail investors to short hedge funds or profit from their losses. But there are seemingly limitless ways to get burned by the industry's omnipresence throughout the financial system.

Hedge funds now manage $2.04 trillion globally. That's the most amount of money ever in the industry's history, according to Hedge Fund Research's June 30 figures.

"Because hedge funds are expected and incentivized to take on a broad variety of risks, they can get killed during bad times from market turmoil and dislocation," says Andrew Lo, the director of MIT's Laboratory for Financial Engineering. "They're tremendously valuable as early warning indicators of oncoming distress."

Overall hedge fund performance has mimicked drops in the equity markets. The Dow Jones Credit Suisse Core Hedge Fund Index was down 3.76% as of August 31 compared to a 3.1% drop in the S&P 500 index.

But many prominent hedge funds have done much worse than the broader market.

Lyxor Asset Management, an arm of French bank Societe General, feeds $11.7 billion from investors into 100 hedge funds through its managed accounts platform, according to Stefan Keller, head of research and external relations at Lyxor. According to documents obtained by CNNMoney, 15 of these funds generated double digit percentage losses as of September 2. Five funds were down more than 20%.

Lyxor does not make these returns public and did not provide these documents to CNNMoney.

According to Lyxor's data, the five funds that generated the largest losses so far in 2011 employed different strategies: Altis Partner's "Altis Fund" fell 21.91% as of September 2 and mainly purchased commodity futures.

Two event-driven and risk arbitrage firms, London's Altima Partners "Global Special Situations Fund" and John Paulson's "Advantage Fund Limited" dropped 24.92% and 23.86% respectively.

It's a terrible world for the markets

Mount Lucas Partners' MLM Fund dropped 25.67% and employs a macro strategy, meaning that it can jump into any type of situation or asset class that appears undervalued. CRM Windringe, a more traditional hedge fund that buys long positions in stocks and hedges with some short positions, fell 24.22%.

Representatives from Altis and CRM Windringe declined to comment on their returns. Altima Partners, Paulson & Co. and Mount Lucas Partners did not return calls for comment.

However, the returns generated on Lyxor's managed account platform need to be taken with a grain of salt. They do not always correlate with the hedge funds' overall returns and often are just a small fraction of a hedge fund's managed assets. Lyxor puts more restrictive terms on the management of the account.

For example, Marathon Asset Management's distressed opportunities fund was down 5.53% on the Lyxor platform as of September 2. Yet, a source with knowledge of the fund's returns says Marathon has posted positive returns.

Why the discrepancy? The source said Marathon's emerging markets fund is up between 7% and 8% for the year. But Lyxor will not allow its managed account funds to invest in emerging markets, the source said.

Still, overall Lyxor data points paint a picture of some of the extreme movements investors should expect from hedge funds.

"For the majority of the funds, managed accounts and the main flagship fund should perform pretty much the same," says Charles Cao, a professor of finance at Pennsylvania State University who has researched Lyxor returns.

"Societe General constantly monitors the difference and discrepancy between the two accounts. One of the requirements of the managed accounts is that you can't have a preferred client that you give your best opportunities to," Cao added.

Hedge fund investors looking to run for the exits will most likely have to wait for two months.

Investors in hedge funds can typically redeem their investment quarterly but must give notice 60 days before the quarter's end. Investors unhappy with August's performance must now wait until late October to redeem funds.

So far, industry observers say investors are not racing out of hedge funds yet.

"We haven't been hearing too much about hedge fund redemptions. Nothing of the scale on what we heard in 2008 and 2009," says Marjorie Asfour, a managing director at Cambridge Associates, which offers investment advice to pensions and endowments.

Still, because the industry is so highly levered and has few assets behind the big bets it takes, hedge funds face one of the quickest life and death cycles of any investment vehicle.

"Big investors might be very disappointed and may start redeeming billions of dollars at a time," says MIT's Lo. "If pension funds and institutions decide to cut their hedge fund exposure in half, there could be huge ripple effects around the market."

That's exactly what happened in 2008 as the global credit crunch unfolded. In March 2008 -- around the time of the government sponsored sale of Bear Stearns to JPMorgan Chase (JPM, Fortune 500) -- several large hedge funds rapidly collapsed due to investors seeking redemptions and banks demanding more collateral for trades and loans.

Among the fallen in 2008: London-based Peloton Capital Partners, a fund that had successfully bet on the subprime crisis in 2007; the Carlyle Capital Corporation, an offshoot of the vaunted private equity firm Carlyle Group; and Dillon Read Capital Management.

Should redemptions pick up later this year, it's difficult to predict exactly how hedge fund implosions will affect the global markets.

"Part of the problem with the hedge fund industry is that there's no transparency and they're not obligated to report to any regulatory industry, so we don't know what the effect will ultimately be," says Lo. "It's a big sword hanging over all of our heads."