Hedge Funds' World of Hurt

In the past, hedge fund collapses were a one-off affair. The 1998 unraveling of Long Term Capital Management's Nobel-Prize brainiacs on bad currency bets and the implosion of Amaranth Capital under infamous gas trader Brian Hunter's wrong-way derivatives trades underscored this point.

The collapse of Dillon Read Capital Management early in the year was a portent of what was to come, though bank officials insisted the subprime crisis was contained. What followed was unprecedented: No fewer than 13 hedge funds have met their tragic demise since the beginning of the year, according to Web site hf-implode.com.

That number includes Sowood Capital, run by former Harvard University money manager Jeff Larson, and United Capital, headed by John Devaney.

Along with the leveraged-buyout titans, hedge fund managers had experienced a golden age of capital raising and fat-cat prosperity. But with investors becoming hip to what appears to be the use by many hedge funds of marginal trading strategies underpinned primarily by the heady use of leverage, fat returns and easy fund-raises from investors, who have plowed billions into alternative investment vehicles, may be a thing of the past.

"This crisis is a little bit more about the marginal investor," says one Connecticut-based fund of funds manager who declined to be identified. "Leverage doesn't make the strategy," he adds. "How good are they? If you're applying leverage to an inconsistent strategy, that's quite dangerous," the fund manager comments.