A series of bad bets by hedge funds which were not able to keep up with markets roiled by the euro zone debt crisis pushed the industry as a whole down 5.2 percent last year, according to Hedge Fund Research.

The second year of losses in four for an industry used to chasing rapid gains from takeovers and restructurings looked especially bad because the benchmark S&P 500 stock index was flat.

Double-digit gains were the norm in the 1990s for firms that demand high fees for their vaunted acumen.

"Many hedge funds are too focused on the medium term and not enough on price action," said hedge fund manager Philippe Gougenheim, the former head of hedge funds at Swiss fund firm Unigestion, who is now launching his own firm.

"For instance, some commodities funds that did not do well last year were too focused on the fundamentals, even when the short-term macro environment was not very good."

Among those that fared the worst were long-short equity funds, which buy shares they expect to rise and sell short those expected to do worse. They lost 8.3 percent last year. Market neutral funds were down 2.1 percent. Commodity funds tumbled 17.3 percent.

"If you make a good fundamental call but the timing is wrong then it could potentially be a bad investment," said Sal Naro, founder of Coherence Capital Partners. "Asset managers are not paid for making sound credit calls at the wrong time."

Peter Rigg, global head of the alternative investments group at HSBC Alternative Investments, said that "with the benefit of hindsight" some funds had not focused enough on short-term issues.

"MORE PRAGMATIC"

The criticism reflects in part the maturity of the $2 trillion industry, which in its early days was characterized by small, start-up funds but which is now dominated by huge, multi-billion dollar funds.

These can be less nimble and can take longer to exit their positions, meaning their bets are often longer-term.

It also shows how some funds have changed their habits and shed their maverick image to accommodate the pension funds and other institutional investors who now dominate the industry.

Funds were caught out last year putting on the so-called pairs trade, in which they match a bet on a rising stock with a bet on a falling stock, often in the same sector.

Such bets rely on low correlations between stocks and only require a manager's view on the differing worth of the stocks to be borne out over a period of time, whichever direction the market moves in.

But correlations between stocks rose sharply last year as they were all caught in the maelstrom and markets flipped between fears over Europe's debts and optimism the problems could be contained. Investors bought and sold almost indiscriminately and pairs traders suffered.

"Fundamentals were no longer relevant in driving performance in (some) underlying asset classes," said Aureliano Gentilini, managing partner at research firm Mathema, saying the same principle applied to commodities as to stocks.

He said some hedge funds had shifted to a "more pragmatic" approach to take account of the changing environment. But even that cannot guarantee success.

"It is hard," said one fund of funds manager who spoke on condition of anonymity. "I do not think you won if you were short term. Fundamentalists who went short term got whipsawed."

So far in 2012, managers including stars Crispin Odey and Lansdowne Partners, who stuck to their guns and suffered losses last year are among those to have performed well.

And John Paulson, whose Advantage Plus fund slumped 52 percent last year after some big bets failed to pay off, was up 5 percent last month.

Gentilini said he expects the U.S. and European economies to decouple this year, presenting new challenges to hedge funds.

"The U.S. will improve on the macro side, which will create a macro environment where fundamental ideas will regain importance," he said. "In the euro zone, I do not think it will be in a situation where fundamental drivers are relevant."

(Editing by Sinead Cruise and Matthew Tostevin)

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