The Whitebox fund's managers have conceded that despite their goal of avoiding "high-risk assets" it was their selection of losing stocks that hurt their portfolio the most.
The firm's largest bets against stocks at the end of September included those against FANGs—Netflix and Amazon, which were up 11 and 32 percent respectively in the fourth quarter, according to Morningstar.
"They basically just got it wrong where the risks were, and they bought things that looked cheap but kept getting cheaper," Kephart said.
In contrast, some of the top performers, such as Vanguard Market Neutral, which was up 5.5 percent last year, picked their losers well. Among its largest shorts at the end of November were several of last year's worst performers, including Platform Specialty Products Corp, Keurig Green Mountain Inc. and Cypress Semiconductor Corp.
In all, however, the long/short equity subset of alternative mutual funds fell 0.9 percent for the year to Nov. 30, while the comparable hedge fund category was up 0.2 percent in the same eleven months.
Among the laggards is MainStay Marketfield, which was once the top-selling alternative mutual fund, but has delivered strongly negative returns for each of the past two years.
Neither MainStay nor Whitebox executives were available to comment for this story.
Yet while fund launches have slowed and closures increased, BlackRock Inc, Blackstone Group LP, Goldman Sachs Group Inc and others have continued to roll out new alternative mutual funds.
With fees of about 1.7 percent of assets per year, according to Lipper, they can be highly profitable for managers. At BlackRock, for instance, alternatives--including such products as hedge funds—account for just 3 percent of assets but 8 percent of so-called "base fees," which includes what the firm charges to manage the money.
While typical actively managed funds usually charge 1.1 percent and those that track an index 0.8 percent, alternative funds cost less than the "two-and-20" common to hedge funds--2 percent of assets and 20 percent of gains.
And last year's shake-out might just what the market needed after years of rapid growth, Morningstar's Kephart said.
"People were in such a rush to get in, raise money and figure out the actual performance part later."
Now, he says, we are finding out who is worth the money.