Hedge funds just posted their worst month in more than a year, according to a new report published yesterday.

Their 1.3% loss in August was the worst performance since May 2006, according to Hedge Fund Research. Funds of funds — hedge funds that invest in other hedge funds — lost 2.1% for the month. These numbers come at a challenging time for the industry. The market is roiling due to the liquidity crunch, and problems in the mortgage market have already forced several hedge funds to close. In addition, Congress is moving forward with several bills that would drastically raise the taxes hedge funds have to pay.

“Hedge fund performance volatility increased at the end of July and has persisted into September,” the president of Hedge Fund Research, Kenneth Heinz, said in a statement. The reasons include “investor concern about continued deterioration in the subprime mortgage sector and the corresponding impact on access to liquidity by both consumers and corporations,” he said.

Another report published yesterday predicts that bonuses at hedge funds will increase just 5% over last year, a far cry from the nearly 20% increase in bonuses that analysts had been predicting. “Two months ago, we expected bonuses to be around 18% above last year, but that was before the market began softening,” a managing partner at the executive search firm Glocap, Adam Zoia, said.

Bonuses are somewhat insulated from hedge funds’ performance because they are paid out of the funds’ management fees — the 1% to 2% hedge funds are paid no matter how they perform. “So even if a fund is flat or down, they can still pay out a significant bonuses,” Mr. Zoia said.

The reason bonuses will likely continue to rise is because “it is so hard to find good people that even if a fund isn’t performing as well, it will pony up decent bonuses just for staff retention,” he said.

Glocap issued the report in conjunction with Institutional Investor News and Lipper Hedge-World.