The big global financial unwinding has been exacerbated if not spearheaded by hedge funds this year. And as we approach December 31, more hedge funds will have to dump stocks to meet investor redemptions.

Hedge funds have failed miserably to protect their investors in 2008, an extraordinarily challenging year for even the most seasoned traders. Some managers, including SAC Capital and Paul Tudor Jones, among the best in the industry, have recently liquidated their entire portfolios and are sitting in cash since September.

Hedge funds have ballooned over the last 20 years. The industry went into overdrive at the start of this decade and won kudos by 2003 for largely protecting investors in the 2000-2002 bear market. Hedge fund assets are estimated at $2.8 trillion dollars through April 30.

The majority of strategies have been massacred over the last 12 months with September the worst month for hedge funds in history.

In 2008, the Credit Suisse Tremont Blue Chip Index of hedge funds has plunged 12.5% through September 30 and is down again thus far in October. In September, the index tanked 7.8% compared to a loss of 9% for the S&P 500 Index and -12% for the MSCI World Index.

The worst-performing strategies include convertible arbitrage (-27%), long/short hedge funds
(-21%) and emerging market hedge funds (-15%). The only sector that has gained in the Credit Suisse Tremont Blue Chip Index is managed futures, up 7.5% this year. Keep in mind that managed futures or Commodity Trading Advisors aren’t even part of the hedge fund family since they trade exclusively in futures and options contracts.

Even the short-sellers, which surged in value leading up to September, were mauled last month because of sudden SEC changes to short-selling rules affecting the financial sector. The short-sellers were hammered in September, down a crushing 18%.

It’s unfair to suggest that all hedge funds are gunslingers. They’re not. Several global macro hedge funds, which specialize in determining macroeconomic trends first and then applying a long/short formula thereafter have thrived this year, mostly because of remaining net short, or betting against the market.

What really irks me, however, is that most long/short equity hedge funds have no clue how to short stocks. Shorting is a highly disciplined technique and most money-managers simply don’t know how to protect capital; yet despite losing big money this year in the worst rout for the markets in more than 75 years, these guys have been charging a 20% incentive fees all along while trailing the S&P 500 Index. What a con-job.

Hedge funds are definitely part of the problem affecting global markets. The vast amounts of leverage they’ve employed are now coming home to roost. This unwinding process is still in progress this week as traders sell just about everything to raise liquidity.

By the end of the year I expect many hedge funds to shutter as margins suffer, incentive fees disappear and investors head for the exits. This boom is now a bust.