One underlying theme that emerges from the Amaranth Advisors blow-up is the question of what hedge funds are supposed to represent? Are hedge funds aggressive, levered, risk-seeking vehicles with pumped up incentive-laden performance contracts? Or are they the low volatility, portfolio diversifiers that industry representatives purport them to be?

The simple fact is that they are both. Given the diverse nature of strategies within the trillion dollar hedge fund industry this should not be all that surprising. What changes from time-to-time is the public’s perception of hedge funds versus some prior reality. Often it takes a front page item to swing public perception from one extreme to another.

We are not the first to note the sometime schizophrenic state of hedge fund publicity. Going Private has a series of post-Amaranth items that note the important role that hedge funds play as risk-seekers. Given the premise blow-ups will happen from time to time, and at least in the most recent case without much market fall-out.

Risk may be a four letter word, but in the context of market innovation it is in fact a compliment.  Accrued Interest highlights a novel area where hedge funds are assuming unwanted risks. In so doing they are in fact making the “..whole system better off.”

The fact of the matter is that it does not necessarily take a blow-up to close down a hedge fund. Oftentimes a slow leak does the job just as well. A trio of writers at the Wall Street Journal report that hedge funds are closing at an unprecedented rate. Given the generally mediocre returns of the hedge fund indices of late this should not come as a great surprise.

The management contracts of hedge funds are, at least for smaller funds, dependent on performance strong enough to induce incentive fees. Absent those incentive feeds, smaller funds are going to have a hard time retaining employees and investors. This shows up in the statistics:

What’s more, the hedge-fund world increasingly is becoming bifurcated, with hot funds run by managers like Eric Mindich’s attracting the buzz — and the bucks from investors. About 300 hedge funds manage more than $1 billion each and represent roughly 90% of the assets in the industry today. “In the older days, raising $100 million was great,” says Richard Portogallo, head of U.S. stocks at Morgan Stanley. “Now it is not going to be good enough.”

It should be noted that even large hedge funds are not immune to personnel turnover. DealBook reports on one high profile hedge fund defector moving back to the safety and security of a Wall Street investment bank. While one person’s career path doth not a trend make, but it does highlight an important point.

Every one involved in the hedge fund business is in a sense taking a risk. Hedge funds are for lack of a better term, small businesses. They are unusually dependent on a stream of uncertain revenues. They rent space and hire employees in order to facilitate their business and often in anticipation of sight-unseen revenues. Investors tie-up their funds for extended periods of time in the hope of market-beating returns. Employees leave often secure jobs for a measure of freedom and the chance for results-based compensation.

Given this analogy, we should not be shocked to see hedge funds start-up and close down with regularity. Simply think about the strip-mall down the road where “lost our lease” and “for rent” signs pop up with alarming regularity. Change is the norm, not the exception.

Absent fraud or willful misconduct, failed hedge funds represent a genuine lost opportunity for manager and investor alike. Nothing in the headlines has changed this fact. Like all capitalist enterprises the hedge fund industry will continue to evolve and it will mean some funds will close and others will open. The only surprise is that any one ever lost sight of this reality in the first place.