Private equity firms have seemingly pushed hedge funds from their perch atop the financial media's front page. But hedge funds are still play a controversial role in the capital markets.

The always excellent James Surowiecki in the New Yorker has a piece that examines how hedge funds transformed themselves from an investment management sideshow to market movers. Surowiecki chronicles how hedge funds have become lightning rods in that they are blamed for all manner of market ills. When one is stumped for the reason behind a price move – simply blame hedge funds.

The fact of the matter is that hedge funds play an important role in all manner of capital market transactions. As investment banks have pulled back from some of their market making activities, hedge funds in many cases have stepped up to fulfill that role. Surowiecki writes that although hedge funds may play a net-positive role in the capital markets that does not necessarily translate down to the limited partner level.

So what’s the catch? Only this: while the proliferation of hedge funds may be good for markets, it may not be good for their clients. The more funds there are trying to make money, the harder it is to get an edge. Even if hedge funds have done well in the past (and that’s an ongoing debate), no one disputes that hedge-fund performance has declined as the hedge-fund boom has got under way. The investors who have given hedge funds billions of dollars in capital in the past few years may end up without much to show for it. It’s their loss, but it’s our gain.

Mark Thoma at Economist's View excerpts the Surowiecki piece and highlights a handful of research pieces on the hedge fund business from the American Enterprise Institute.

Bill Sjostrom at Truth on the Market also weighs in, emphasizing the positive role hedge funds play in the operation of the financial markets.

DealBook notes a forthcoming speech from Fed chairman Bernanke on the role of hedge funds in the capital markets.

For all those critics of hedge funds, if it weren't for hedge funds we wouldn't have that cinematic masterpiece – Poseidon. Oh wait, maybe that is a reason to regulate hedge funds…