2014: The year hedge funds fight back

Will hedge funds prove their worth in 2014?

It has been a tough year for hedge funds, criticized for lagging behind the markets and producing poor value.

But hedge funds have hit back at the skeptics, insisting 2014 will be their year.

"The headline for the year will be, 'Hedge funds will prove their worth'," Andrew McCaffery, global head of hedge funds at Aberdeen Asset Management, told CNBC in a phone interview.

In the extraordinary equity rally last year hedge funds -- which use borrowed money to generate returns in both bull and bear markets -- were trumped by the major developed market indices' huge gains.

(Read more: Guess which hedge funds beat the roaring S&P 500 this year?)

Hedge funds trailed the S&P 500 for the fifth straight year in 2013, according to the Bloomberg Hedge Funds Aggregate Index, in a year that showed the stock index rally 30 percent.

The funds also lagged behind the S&P 500 by 23 percentage points last year, returning an average of 7.4 percent in 2013. Only 16 hedge funds on Bloomberg's top 100 list out-performed the S&P.

Chris Price | E+ | Getty Images

But McCaffery said fund managers were focussing on long-term gains and diversified strategies rather than concentrating purely on beating the market.

"First of all, a number of hedge funds are not going to just investing in equities. Too many times it is presented that hedge funds are there to outperform a stock index, but a majority are trying to produce longer term in compound positive returns," McCaffery said.

(Read more: 3 big hedge fund predictions for 2014)

His optimism comes from his belief that the correlation between the price of individual stocks and their sector as a whole will be low. This is creating more "dispersion" in the value of stocks, making 2014 all about individual stock-picking, in contrast to last year which saw only 10 percent of stocks in the S&P 500 post negative returns.

"There will be the opportunity to differentiate between assets more and some of the elements driving market movements will be go back to fundamentals, rather than a sea of highly correlated movement together. Last year was amazing how bunched up returns were," McCaffery told CNBC.

"I think you'll see hedge fund manager returns look better…I think (for) those who can…move across different sectors and be flexible in that risk taking, (it) is going to be quite an exciting environment because volatility will give them opportunity as well."

(Read more: The 10 stocks that hedge funds love most)

Some analysts are anticipating a less-buoyant stock market in 2014 as the U.S. Federal Reserve continues to taper its bond-buying program, which flooded new money into the market and propped up equities, while investors look towards company fundamentals.

In this environment, there is a larger opportunity for shorting stocks, and the real worth of hedge funds will be realized, according to Pedro De Noronha, managing partner at Noster Capital.

"It is a very necessary industry and people will realise how necessary the hedge fund industry is once the market turns down and they start losing money on their long only funds," Noronha told CNBC in a TV interview.

—By CNBC's Arjun Kharpal: Follow him on Twitter @ArjunKharpal