2004: Hedge Fund Craze Unlikely to Ebb

Hedge funds spent 2003 living off their reputation for performance, even as that performance wilted. Investors, however, are unlikely to lose their taste for them in 2004.

The average hedge fund returned a bit more than half of what an S&P 500 index fund netted this year. Despite that, investors in these exclusive, largely unregulated pools of capital set an annual inflow record before the third quarter was even over: $45.4 billion in new hedge fund investment, according to Tass Research. Investors put $16.3 billion into hedge funds in 2002 and $31 billion in 2001. Tass tracks about 4,000 funds in its database.

The jump in hedge fund investments in the first three quarters of this year will continue in 2004 and beyond, say hedge fund experts and investment advisers.

Hedge funds are not for everyone -- by design, only wealthy investors and institutions can invest in most of them. Those constituencies show no signs their ardor is fading. Many investment advisers also believe hedge funds will soon become more accessible to retail investors, which could mean large amounts of additional capital becomes available. It's far from certain they will, however. The Securities and Exchange Commission is widely expected to bolster its supervision of them next year, but whether that will make it easier to buy in is not yet clear.

Even at a time when these largely unregulated funds are under close government scrutiny, they remain the alternative investment of choice for institutions, and a wise option for diversifying portfolios for the wealthy and semiwealthy.

"This is very broad-based participation [in hedge funds], because many people don't trust the rally," says Bob Schulman, the co-chief executive of Tremont Capital Management, a Rye, N.Y., unit of OppenheimerFunds. Schulman says once-burned investors would prefer to let someone else run their money this time around.

"They do not want to get their equity exposures back up to 60%, 70% or 80% -- whatever they ran to in the bubble," he said.