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This article was authored by William Sword Jr. and Lee Gladden. William Sword Jr. is managing director of Wm Sword & Co., Princeton, NJ, an investment banking firm that advises private equity and alternative investment clients. Lee Gladden is a member of the international advisory council for Wm Sword & Co. as well as president of Princeton International Management:

It wasn't supposed to turn out like this. Hedge fund managers' assurances of absolute returns and liquidity in diverse environments were not honored last year amid a global financial credit crisis in which even the most historically liquid markets became treacherous to navigate and difficult to transact in.

As they take stock, institutional investors are hardly comforted by the knowledge that losses in their U.S. and international equity portfolios in 2008 ranged from one-third to one-half of total value, while hedge fund returns were on average down only approximately 15-20 percent. Nor are they pleased that redemption requests were sometimes fulfilled and other times delayed as many hedge fund firms sought to limit or block withdrawals.

This year will test the hedge fund business like no other to date. With mounting redemption calls, dim prospects of earning performance fees for many funds, and the absence of the leverage that helped turn even average managers into stars in earlier benign market conditions, the challenges are indeed severe.

While we're confident the overall appetite for hedge fun......................

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