Hedge fund performance slumped in 2007, according to a new study by Greenwich Associates and Global Custodian.

The proportion of hedge fund managers earning double-digit investment returns dropped dramatically from 2006 to 2007, it said. Among hedge fund managers participating in the research, the proportion reporting returns better than 10% dropped from 62% for calendar year 2006 to just 52% for 2007. Over the same period, the share reporting returns of 5-10% increased to 23% from 21% and the proportion reporting sub-5% returns rose to 15% from 12%. Within this group of 1,355 hedge funds, the proportion reporting negative returns jumped to 9% in calendar year 2007 from just 5% in 2006.

In particular, the global credit crisis has taken a heavy toll on hedge funds focused on fixed income, Greenwich said. About two-thirds of funds investing at least half of their assets in fixed-income related strategies generated returns better than 10% in calendar year 2006; in 2007 that share plunged to 43%. Over the same period, the share of these funds reporting returns of 5-10% increased to 30% from 22%, and the proportion with returns of 0-5% increased to 19% from 11%. “Eight per cent of these funds reported negative returns for 2007, up from just 2% for 2006,” says Greenwich Associates hedge fund specialist Karan Sampson.

Although equity-oriented funds as a group fared better than fixed income funds, many saw significant declines in performance, Greenwich noted. The share of equity-focused funds reporting returns in excess of 10% dropped to 55% for 2007 from 63% for 2006.

On a geographic basis, the only region in which hedge funds as a group seemed to maintain their performance levels from 2006 to 2007 was Asia-Pacific, in which the share of managers reporting returns of more than 10% actually increased slightly to 63% from 62%. The U.S. saw the biggest downward shift, with the proportion of U.S. hedge funds exceeding 10% in annual performance dropping to 53% for 2007 from 64% for 2006, while the proportion reporting negative returns jumped to 10% from just 4%. Performance appears weakest for European-based funds, with just 46% reporting double-digit returns for 2007, down from 53%.

With industry-wide performance on the decline, the hedge funds participating in this year’s study reported holding a full 15% of their total assets under management in cash at the beginning of 2008. Cash levels were slightly higher among hedge funds in Asia (17%) and Europe (16%), it noted. Equity-oriented funds had 14% of their assets in cash, and fixed income-focused funds had 17%. Among the world’s biggest hedge funds, nearly 12% of assets were invested in cash.

Meanwhile, hedge fund industry leverage ratios declined to about 2.1 at the end of 2007 from 2.3 a year earlier. Overall gross leverage ratios for fixed income-oriented funds declined to an average of approximately 3.0 at the end of 2007 from 3.4 last year, Greenwich said.

“In Europe, where hedge fund strategies are more heavily weighted toward fixed income, overall leverage ratios declined to 2.3 from approximately 2.8,” says Greenwich Associates consultant John Feng. “The pullback was more modest in the United States and Asia Pacific.”

Additionally, the share of European hedge fund managers experiencing net redemptions increased significantly from calendar year 2006 to 2007. Just over a quarter of European hedge funds participating in the Greenwich Associates/Global Custodian study reported net redemptions in calendar year 2007, up from 21% in 2006. Among U.S. hedge funds, that share was unchanged at slightly more than 25%. The situation was much different in Asia, where the share of hedge fund managers reporting net annual redemptions actually fell to just 15% in 2007 from 22% the prior year.