Jan. 8 (Bloomberg) -- Hedge funds lost 18.3 percent in 2008, their worst year on record, as managers misjudged the severity of biggest financial crisis since the Great Depression.

A gain of 0.42 percent in December lessened the average loss for the full year, according to Hedge Fund Research Inc.’s HFRI Fund Weighted Composite Index. The decline was the most severe since the Chicago-based firm began tracking data in 1990.

“Hedge funds failed to appreciate the magnitude, breadth and duration of the declines we saw across most markets,” said Michael Rosen, principal at Angeles Investment Advisors LLC in Santa Monica, California, which advises clients on investments.

Losses and withdrawals reduced industry assets to $1.1 trillion last month from its peak of $1.9 trillion in June, according to Morgan Stanley. Firms such as Dwight Anderson’s Ospraie Management LLC and Jeffrey Gendell’s Tontine Associates LLC closed funds, while Paul Tudor Jones’s Tudor Investment Corp. and Kenneth Griffin’s Citadel Investment Group LLC were among those to limit the money that investors could withdraw after losses.

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested.

To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net

Last Updated: January 8, 2009 14:54 EST