2007: Crazy Happens, Part 1

This column was originally published on RealMoney on Dec. 21 at 3:00 p.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Writing in a Forbes column about what he sees as an unsustainably low valuation for a French telecom stock, money manager Ken Fisher wrote, "Crazy happens in France." I believe crazy happens in the U.S. financial markets, too.

Among other things, I think it is crazy that more than 9,000 hedge funds are in existence. Hedge funds are the highest-cost legal investment option in the free world. The expenses that hedge fund investors bear put variable annuities, front- and back-loaded mutual funds and broker-wrap accounts to shame. The typical fund carries an annual expense ratio of 2%, plus a percentage of the profits on the order of 20% or more.

Taken alone, high expenses should not be a deterrent to investing in the best hedge funds. I'm in favor of paying top dollar for consistently tremendous performance produced by certain elite hedge fund managers such as George Soros, Michael Steinhardt, Ed Lampert and Steven Cohen.

Let's be generous and classify the entire top decile of hedge fund managers as geniuses. That would imply that roughly 900 bona fide superstars are now operating hedge funds. (If you're smart and wealthy enough to hire one of them to manage part of your portfolio, allocating some capital to them may make sense. But you'd better be lucky, too, because many of the best managers' funds are closed to new investors.)

So if you agree with the rather generous notion that about 900 hedge fund managers are geniuses of capital allocation who deserve enormous fees, that leaves more than 8,000 mere mortals operating hedge funds. Almost all of these funds operate under fee structures that are similar to those of the superstars, and a good number of them are simply leveraged risk pools (beta machines), not traditional hedged vehicles. As such, they could hit a mind-blowing home run (see T. Boone Pickens), but they could also blow up and go to near zero (see Amaranth).