Hedge Funds Post Worst Month in Five Years

A tumultuous market on Wall Street is battering hedge fund managers harder than they've experienced in years.

Hedge funds saw their worst month performance in about five years in January, generating a composite loss of 2.46%. It's the group's worst month since July 2002, when funds saw a loss of 2.86%, according to Chicago-based industry data group Hedge Fund Research.

Many hedge funds use leverage provided by banks in order to boost their returns. Conversely, losses also can be magnified when the rapid depreciation of asset values compels lenders to ask their borrowers to post more collateral to support their leveraged bets.

Troubles for hedge funds began last summer when the credit markets encountered an unprecedented seizing spurred by the deterioration in housing. Fast forward to the first quarter of 2008 and many funds are finding that things have only gotten worse, especially given that investment banks such as Citigroup(C Quote - Cramer on C - Stock Picks), JPMorgan Chase(JPM Quote - Cramer on JPM - Stock Picks), Bear Stearns(BSC Quote - Cramer on BSC - Stock Picks), Merrill Lynch (MER Quote - Cramer on MER - Stock Picks) and others are tightening the screws on their underwriting in an effort to keep borrowers on much shorter leashes.

That's exactly the sort of tightening that $1.6 billion hedge fund Peloton Partners faced when it was forced to unload billions in esoteric mortgage-backed assets that had fallen in value suddenly in order to meet calls for more capital from its lenders.

The Peloton implosion is a sobering turnabout for a fund, founded by former Goldman Sachs(GS Quote - Cramer on GS - Stock Picks) partners Geoff Grant and Ron Beller. The hedge fund operation had been up by nearly 90% last year because it had smartly picked the right side on mortgage security trades. But over the past several weeks, the fall in values of certain mortgage securities and the firm's heavy use of leverage proved a fatal combination.

Santa Fe, N.M.-based lender Thornburg Mortgage(TMA Quote - Cramer on TMA - Stock Picks) also has been the subject of mounting margin calls that could be putting it and other financial firms at the precipice. Thornburg saw its stock plummet more than 60% to well below its 52-week low, after saying that it faced new calls from lenders requiring it to post some $270 million in capital on top of the $300 million it already disclosed it had to post last week.

Thornburg's and Peloton's pain are the sorts of narratives that Wall Street fears could play out at other organizations and hedge fund shops as banks and brokers rein in lending amid plummeting prices.

Hedge funds faced a woeful November, when HFR's data showed that the firms posted a composite loss of 2.18%. In the new year, uncertainty lingered and new worries about bond insurers and other arcane aspects of the market continued to unsettle investors.

But some hedge funds can boast some relative positives.

Hedge fund firm Och Ziff Capital Management Group(OZM Quote - Cramer on OZM - Stock Picks) -- one of a few publicly-traded hedge funds -- has had a rough start to the year, but reported modest gains in February as its peers saw losses.

Och Ziff's best performing hedge fund, the OZ Asia Master Fund, returned 1.82%, according to public filings. The fund also grew assets to $33.6 billion, adding $520 million.