Hedge Funds Go For a Makeover

But many industry observers expect June will be a lackluster month for the indices that provide the best indication of how hedge funds are performing. The Credit Suisse First Boston/Tass Tremont index suffered its first loss in 17 months in April, dropping 0.58%. That was followed by an average loss of 0.23% in May. Nevertheless, it's still up 2.58% through the end of May.

"There has been very low [market] volatility," Metzger said. "Low volatility does not help strategies like convertible arbitrage or statistical arbitrage." With the benchmark S&P 500 index down 0.5% for the year to date, the absence of wide market swings hasn't provided much lift for long-short equity funds, which tend to have a higher correlation to the stock market than other hedge fund strategies.

David Kabiller, a partner at AQR Capital Management, says investors have matured along with the hedge fund market. While he thinks June results will be "flattish or down," he says investors are now looking to hedge funds more to preserve capital than to garner stratospheric returns. Hedge funds have responded, and are touting their risk management virtues the way a salesman pushes the safety of a Volvo sedan, rather than the flash of a Ferrari.

"U.S. equity markets have delivered negative returns over multiple years, and we're still comfortable with that from a long-term point of view," Kabiller said. "When you start looking at investment horizons on a monthly or quarterly basis, the investor who does that can get whipsawed."

But a recent report by Merrill Lynch says that funds of hedge funds -- the main choice of first-time investors -- fail to deliver the best possible returns.

Hedge funds are expensive by any measure. Most charge a 2% annual management fee and take 20% of any profits, while funds of funds -- which spread risk around by investing in a basket of single-manager funds -- add another 1% to 1.5% fee on top of that. Some funds of funds also charge incentive fees as high as 10%, making them a costly proposition.