The selloff in most of the global markets in the third quarter heavily impacted a large number of hedge funds.

In fact, not only did it put many funds into the red for the year, it pushed a huge number of hedge funds below their high water mark.
According to HFR, at the end of the third quarter just 19.3 percent of all hedge funds were above that critical level that determines whether their investors’ accounts are in the black. This is way down from 44.2 percent at the end of the second quarter and less than half the level of each of the three prior quarters.

In fact, the 19.3 percent is the lowest level since the end of the first quarter of 2009, when it bottomed at 18.7 percent, by far the all-time low since HFR began keeping score in 2003.

But even the 19.3 percent figure could be overstating how the average investor in those funds is faring in general. While those invested in these underwater funds for many years before the current slide could still be in the black, many hedge funds with good long-term records traditionally gather the biggest chunk of their assets after their big run-up.

So, this means many of them made their initial investments at or near that recent high water mark.

A good example are the large number of investors who gave money to John Paulson’s funds after the manager’s gargantuan gains in his reputation-making 2007.

The 80 percent or so of funds that are currently in the red probably explains another interesting statistic trotted out by HFR.
While hedge funds altogether experienced net inflows of $8.7 billion in the third quarter--the ninth consecutive quarter in which the industry has experienced net inflows—HFR estimates just 39 percent of all funds were recipients of net new money. The rest—61 percent—experienced outflows.

This is exactly reverse from the prior quarter, when 61 percent of funds received new capital from investors. This reversal of fortune possibly suggests investors have become more discriminating. On the other hand, they also may be chasing performance, a historically foolish strategy frequently repeated by investors.

Still, in the nine quarters that HFR has been estimating this statistic over the last two years, typically 60 percent to 70 percent of all hedge funds experience inflows and the rest outflows. (see table below).

Quarter  Q3 2011  Q2 2011 Q1 2011  Q4 2010  Q3 2010   Q2 2010  Q1 2010 Q4 2009  Q3 2009
 Inflows  39%  61%  72%  71%  57%  59%  60%  67% 68%
 Outflows  61%  39%  28%  29%  43%  41%  40%  33% 32%

Percentage of estimated number of funds. Source: HFR

Altogether, performance declines in the third quarter pushed total industry assets under management below the $2 trillion mark, to $1.97 trillion.

However, given the net inflows for the quarter, many investors still don’t seem to mind that  a large number of hedge funds are not delivering.