Hedge funds suffered their worst returns in four years at the end of last month after a storm of market shocks hit many investment strategies.

The Hedge Fund Research index of investable hedge funds dropped just over 3 per cent in the week to July 27 as global markets swung wildly. It was the most significant fall recorded by the index since its inception in 2003.

Investors, nervous about the credit markets’ ability to soak up billions that have been lent on private equity deals, foresaw a fall in the number of leveraged buyouts and dumped equities as a result. Worries about a wider economic slowdown hit the commodities markets, causing oil prices to fluctuate.

Man Group’s $18.5 billion (£9 billion) AHL Diversified Futures Fund, one of the most publicly visible funds, fell 6.7 per cent in the week to July 27.

AHL is a quantitative fund, which means that its investments are based on computer models that identify trends in the movements of different asset classes. The models can be thrown by unexpectedly large gyrations in the markets, although they can quickly correct themselves. The 20-year-old fund is due to report its results for the week to August 3 today.

A manager at a leading fund of hedge funds said that several investment strategies used by hedge funds were affected by “major market distortions”.

“It was pretty bad for quite a few funds, with major distortions in credit and equities, and even natural resources, where oil went up like nuts and then down like crazy,” he said.

He said that funds could not make enough on their short positions to make up for losses on their long investments. Longer term, those that tended to short blue-chip stocks would be caught because the flight to quality by nervous investors pushes up the price of the safer shares.

Funds that can afford to sit out the turbulence without having to unwind their positions would be able to recover the falls in their value, he said, but those that cannot would turn “unrealised losses into realised losses and then they won’t make it back”.

But Hedge Fund Intelligence, the research and publishing house, said yesterday that it was too soon to assume that July was a dire month for all hedge funds. A spokesman said that the independent administrators for funds with more complex strategies took more than a week to evaluate the funds’ performance.

“We’ve only got returns from 15 per cent to 20 per cent of European funds so far,” he said. “We think it’s too early to call.”

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