Jan. 23 (Bloomberg) -- Hedge funds lost more money in 2008 than any year on record. It may get worse in 2009, forcing fund managers to overhaul investment strategies, reduce fees and make it easier for clients to withdraw cash.

The $1.2 trillion industry may shed as much as $450 billion in assets, or 37 percent, through market losses and client withdrawals this year, according to Morgan Stanley analyst Huw van Steenis in London. That’s on top of the $600 billion that disappeared last year and would leave hedge funds with $750 billion, the lowest since 2002.

“It’s hard not to be bearish in this environment,” van Steenis said in a telephone interview.

Investment returns fell an average of 18 percent last year, according to data compiled by Hedge Fund Research Inc., the most since the Chicago firm began tracking the industry. While that beat the 38.5 percent loss by the Standard & Poor’s 500 Index, many investors were angered when fund managers limited or froze withdrawals. Funds will have to reduce fees and loosen redemption rules to win back client confidence, said Craig Lilly, an attorney at Washington-based Squire, Sanders & Dempsey LLP.

“They will have to unilaterally cut their management fees in order to ensure the flow of capital from investors,” he said.

At least 20 percent of hedge-fund assets were subject to redemption restrictions last year, according to Peter Douglas, principal of Singapore-based consulting firm GFIA Pte.

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