The results are in: Absolute hedge-fund returns may not exist, but the smartest and most sophisticated investors on Wall Street still outperformed the broad markets by a wide margin.

Hedge-fund headlines have been dominated by dour news about weak performance, clients' redemption demands and the closure of funds that were overweighted in risky bets that went bad. But the flip side to that story is that the average fund still beat the broad market by about 20 percentage points.

"Investors would have lost less money in 2008 by investing with the average hedge fund than with the average mutual fund, index fund, or long-only manager," notes Jack McDonald, CEO of Conifer Securities, which executes trades for over 100 hedge funds.

In fact, according to research by Credit Suisse/Tremont, about one-fifth of hedge funds generated positive returns, and 14% posted double-digit performance -- proving that not all strategies were losers in 2008. The market is still incredibly risk-averse and waiting for more clarity on the economic horizon, but it's worth examining what strategies worked and why, and where remaining capital may flow.

Winners and Losers

Naturally, as the stock market fell precipitously, short-biased funds were among the top performers. Macro funds, which use broad strategies to profit from big-picture economic trends, also performed well, as did commodity-trading adviser (also known as managed futures) funds.

On the other side of the spectrum were less diversified funds that were betting on upside, whether in equities, emerging markets, energy and materials. Any strategy that relied on markets whose liquidity dried up -- say housing bonds, or certain complicated and risky derivatives -- were driven down further via forced selling.

"There's a lot of red on that page," is how Chris Keenan, who oversees marketing for Welton Investment Corp., describes performance of various hedge-fund strategies last year. "A lot of people classified these strategies as absolute return and I think that marketing pitch is being revisited."

As a commodity-trading adviser, or CTA, Welton seeks to profit from opportunities in a wide variety of futures markets, including stock indices, commodities, interest rates or currencies. Keenan promotes it as a "perennial strategy" rather than a hot one for 2008, saying its diversifying performance balances out portfolios well.

Indeed, the lessons to be learned by hedge-fund managers in 2008 seem to revolve around diversification, risk management and judicious use of leverage. Funds have also begun to show flexibility with colossal fees to placate enraged investors who expected absolute returns from absolutely every bet. New regulatory measures will likely push for enhanced transparency as well.

"There is a lesson to be learned from '08," says Sol Waksman, president of the alternative-investment data provider BarclayHedge, "and that lesson is this: Investing is risky. Never lose sight of that."

Another important lesson for retail investors is that hedge-fund managers have sophisticated tools at their disposal that the average Joe simply doesn't -- whether those are quantitative analysis techniques, research analysts, complex investment vehicles or huge sums of money to boost returns. Even if those tools were at a retail investor's disposal, says Waksman, the large majority of average Joes don't have the breadth of experience or intuition that the experts do.

"Why should the average retail investor who has a day job think that he should successfully compete against the professionals?" says Waksman. "They can try. But are you going to go to Las Vegas and sit in on a poker game with professional gamblers? Only if you have a severe self-destructive streak."

Still, average investors can still learn something from the carnage of 2008 and the hedge funds that performed exceptionally well. Behind all the complicated techniques and enhanced returns were theories about the markets and the economy that any investor could have formulated, and from which any nimble investor could have profited handsomely.

Of the top-performing funds, superstar hedge-fund manager John Paulson --whose $36 billion hedge-fund company Paulson & Co. had four of the top 20 performing funds, according to

Bloomberg

-- correctly predicted that there would be a severe crisis in the mortgage, and then broader credit markets. Others bet correctly that banks heavily exposed to such debt would crumble, or that the government would respond to the economic crisis by slashing interest rates. Still others predicted that oil prices would surge in the summer as the dollar suffered, or that they'd plunge as the greenback picked up strength.

Any investor could acted on such beliefs and made similar bets, albeit with simpler vehicles and far less capital.

"There's nothing stopping Joe the Plumber from having spectacular returns in his or her personal account next year," says Conifer's McDonald. "Part of that comes down to what your perspective is on what level of skill vs. luck is required to successfully invest in these markets."

The Next Strategy

A few things are almost certain in 2009, though the timing and effects of these consensus opinions are unclear: The recession will play out further; a stimulus package will be approved to moderate its effects; some companies will fail while others merely cut back and slow down.

With each tidbit of economic or earnings data comes a new swing in the stock market as the

Dow Jones Industrial Average

fluctuates within the 7,000 to 9,000 range. Hedge funds are coping with the fallout, flooded with redemption requests from disappointed clients, and liquidating assets to reweight into cash.

The question some have started to ask is, which field will hedge-fund survivors flock to once they've stabilized and jumped off the sidelines?

Some are taking advantage of vacillating stock prices, particularly as blue-chip names like

Microsoft

(MSFT) - Get Report

,

Intel

(INTC) - Get Report

,

General Electric

(GE) - Get Report

trade at a steep discount to recent peaks. Other Dow components like

Alcoa

(AA) - Get Report

and

Citigroup

(C) - Get Report

are valued at a mere fraction of their 52-week highs - though there are reasons for such depressed prices.

Another area that has received heightened attention is the

corporate bond

market, where prices have become very attractive for investors with the risk tolerance and financing to make such bets. The two reasons for that are heightened desperation on the borrower side, and heightened risk on the lender side, according to David Gold, a senior hedge-fund investments consultant at Watson Wyatt Worldwide.

"Companies need to find other ways to raise new capital or go bankrupt," says Gold. "So the distressed investment space is definitely opportunistic looking forward, but the amount of securities that look truly attractive is very thin, especially on the corporate-credit side."

Still, the topic has been brought up quite a bit in elite investment circles, including Paulson, whose $36 billion hedge-fund company Paulson & Co. sent a letter to investors saying certain distressed-debt opportunities seemed attractive.

Steve Wyatt, chair of the finance department at Miami University's Farmer School of Business, says that's where he would invest his own money and others ought to "be looking very seriously" at such investments as well.

"Stocks look cheap," says Wyatt, "but corporate bonds are ridiculously cheap. At one point they were being priced as if one in four corporations in the U.S. were going to go bankrupt."

For now, investors seem to have their feet still firmly planted in the safest of safe bets, until it is clearer how deep the recession will go and how long it will last. Unfortunately, it's impossible to predict such things with any specificity. But as the investor who bought subprime mortgages, commodities, or major financial stocks at their recent heights knows, waiting for the rest of the market to act is a bad idea, and the last one out will be a rotten egg.