The worm seems to have turned on the hedge fund industry. Some interesting comments follow.

Aaron Pressman in notes that inflows into hedge funds ground to a halt in the fourth quarter of 2005. Indeed on hedge fund manager describes it as a “recession for hedge funds.” Pressman writes that a combination of poor returns, competition from private equity, egregious fees, and high profile blow-ups have put many investors off of hedge funds.

A new blog, Truth on the Market noticed this article and noted a number of hedge funds had already closed through the third quarter and that there seems to be “sector rotation” going on in the world of alternative investments.

Jenny Anderson in the New York Times states that trying to gauge the performance of the hedge fund sector is “no simple task.” There seems to be a sizeable difference in returns between investable and non-investable hedge fund indices. The investable funds seemed to have lagged badly in 2005.

There are a number of different hedge fund index providers and they all have slightly (and not so slightly) different methodologies for calculating performance. Anderson notes that,

Many sophisticated investors develop their own benchmarks, or they set an absolute return objective. Not all hedge fund investors are so sophisticated. For those who are not, and who happen to be piling into hedge funds, it is worth finding a reliable benchmark.

Daniel Gross noticed the same article and highlighted the fact that according to Burton Malkiel, “The bottom line is, there is a lot of survivorship bias in many of the hedge fund indices that are used to sell hedge funds.” Buyer’s remorse anyone?

As with most booms there is going to be a shakeout in the hedge fund world as well. The only question is the size and timing of the pullback. Most individual investors are well-served by avoiding the hedge fund industry in large part to the high hurdles for due diligence. For intrepid investors they can look to the more regulated (and transparent) world of hybrid funds.

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