The equity markets trade like we are on the verge of the next Great Depression. De-leveraging in the emerging markets is leading to what some would call the annihilation of several of the most recently popular markets, such as India and Brazil. The fixed income markets have nearly become non-functional at times, with both short-term and long-term lending severely impaired. Nearly every major bank in the world has sought capital from its government. Bear and Lehman, amongst others, are gone. In short, the financial world is in disarray.

So what about hedge funds? Have they fulfilled their role in muting investor pain in times like these? What will investor appetites be like after the carnage is over? How many hedge funds will we have after the dust and blood disappear?

Obviously, none of these questions have a simple answer. Times like these were theoretically made for hedge funds, but hedge funds have suffered greatly as well. Several emerging market funds which had enjoyed high double digit and even triple digit gains in the last couple of years are now crashing with 70%, 80% or even 90% losses for ’08. Many long-short equity funds look almost like the S&P while correlations for nearly all strategies appear to be rising to one. Even relative value strategies and market neutral strategies have been hammered.

De-levering and fear of redemptions have obsessed much of the hedge fund world for the last two months as some estimates for year-end redemptions run as high as 10% of the outstanding $2 trillion assets currently estimated in the space. There is little solace to be found in the fact that the average hedge fund, which is likely down in low double digits year to date, has done better than the average long-only manager. Most investors seem far more concerned with what to do with their existing hedge fund managers as opposed to entertaining an introduction to new ones.

It may not feel like it now, but this environment will end. The only question is when. So what does this mean for the hedge fund world? Our space definitely needs revamping as we once again deal with the realization that leverage is far more a function of risk than return. Increased volatility in itself affords one the ability to achieve outsized returns without the use of leverage. In fact, one could make the case that there is a six- to seven-year cycle of “Black Swan” type events dating all the way back to 1974. The only difference with this event as opposed to prior Black Swan-type market dislocations, is its magnitude.

In fact, one could argue that this type of watershed event is a needed cleansing for the hedge fund industry to reduce the number of marginal managers. It is obvious now that there are too many funds and too many people in the space that do not understand how to manage risk effectively. But let’s not dwell on those entities who are destined to fail. Rather, let’s turn our sights to those who either have managed through this dilemma or who have actually excelled in this environ. There is always and will always be a need for good hedge fund managers; there is just no room for the pretenders now.

The views expressed in this column do not necessarily reflect the views of Channel Capital Group. Inc.