Investors lost their appetite for hedge funds in 2008, Morningstar says, as the vehicles intended to deliver absolute returns were forced to resort to relative claims of success.

"In 2008, hedge fund managers generally failed to deliver," said Morningstar Hedge Fund Analyst Nadia Papagiannis. "The average hedge fund may have lost less than the stock market, thanks in part to large cash allocations, but this level of performance was not why investors agreed to pay 2% management fees and 20% performance fees."

Hedge fund inflows peaked in June 2007 and bottomed in October 2008, when more than $21 billion left the industry. In November 2008, another $19.4 billion flowed out of hedge funds, setting the year-to-date outflows at more than $44 billion.

The number of funds dropping out of Morningstar`s database increased more than 150% in 2008 from 2007—1,158 single-manager funds and 490 funds of funds were removed in 2008 compared to 434 single-manager funds and 208 funds of funds in 2007. (Funds are removed from Morningstar’s database if the fund liquidates, if the manager wishes to stop reporting returns, or if funds fail to report returns for six months.)

Emerging market equities proved to be the worst strategy in 2008, along with convertible arbitrage funds, which took a big hit in 2008.

The best-performing strategy this year was global trend following, a systematic strategy that tracks price trends in liquid derivatives such as futures, options, and currency forwards.

Morningstar has approximately 8,400 hedge funds and funds of hedge funds in its database.