With the fourth quarter a month old, 2005 is shaping up as a brutal year for hedge funds. Anyone perusing the business press over the weekend saw a slew of stories highlighting the problem.

A lot of funds still are in desperate need of a big trade or two to achieve the kind of returns their clients have historically demanded. Until now, a major problem had been a lack of volatility in the stock and bond markets, but that trend looked to be ending finally with the wild action of the last two weeks.

Still, many strategies continue to struggle. Among the laggards, according to fund-of-funds managers who spoke to TheStreet.com, is the equity long/short category, an established, well-understood and nonesoteric strategy. Because it's popular, a bad idea in this space can hurt a lot of bottom lines. One example has been a propensity among managers to buy energy shares while going short retail. That approach has been a loser as crude prices have declined.

Another dangerous sector has been merger arbitrage. "People are getting killed. Too many deals get busted," complains an investor. Last week's example was School Specialty ( SCHS), a Wisconsin-based provider of education services and tools. Last Tuesday, Bain Capital announced that it was canceling a plan to buy the company. The following day, the stock fell by 9% to $34.11; it was trading for $33.75 on Monday morning. Obviously, merger arbitragers who were long the stock got hurt.

Other high-profile blowups in the space have pushed some arbitragers into the realm of shareholder activism. One that has adopted the activist toolkit is Paulson & Co. Last week, the New York hedge fund, which owns 19% of Canadian steelmaker Algoma Steel, demanded a recapitalization of the company and called for a special shareholders' meeting before year-end to replace a majority of the directors. The Ontario-based company has rejected Paulson's demands, saying its decision to pay a special dividend instead was the prudent move during an "uncertain time in the steel industry's cycle."

Speaking of activists, hedge fund Jana Partners likes coal miner Massey Energy ( MEE). Last month, the hedge fund bought 5 million shares of the Richmond, Va.-based company, a 6.5% stake, saying it was undervalued, according to a regulatory filing. Last week, Jana boosted its position to 5.79 million shares, or 7.5%. Meanwhile, the stock has gone from $48.83 on Sept. 7 when Jana filed its 13D schedule to $40 Friday, the last leg courtesy of a Merrill downgrade.

Jana, which is best known for its activist work with Carl Icahn at Time Warner ( TWX) and Kerr-McGee ( KMG), joins a lengthening list of shareholders at Massey that want the coal company to consider a big stock buyback.

Too Small

The new Securities and Exchange Commission regulation forcing hedge funds to register as investment advisers continues to be a sore spot -- even at the SEC. One source of friction has been the requirement that any fund with more than $25 million of assets must comply, a threshold that is considered awfully low by many.

Last week, the Financial Times reported that Lori Richards, the SEC's compliance director, said the agency was having "a lot of discussions" about whether to raise the minimum asset size threshold.

An SEC spokesman, John Heine, said there has indeed been "a lot of discussion," but at the staff level, not among commissioners. "Of course, the staff has an influence and makes recommendations that the commission considers. But there is no proposal to that effect at this point," he says.

Moving On

Tremont Capital Management, the $10 billion hedge fund of funds powerhouse, has a new president. Rupert Allan, who headed the company's European and Asian operations out of London, will step into the post in January, replacing Barry Colvin, who said he is leaving to pursue "new entrepreneurial ventures," according to his boss, CEO Robert Schulman. Colvin had been with Tremont for six years, first as head of research and then as president since 2002.

Meanwhile, Clinton Group beefed up its leadership. The New York hedge fund nabbed Thomas Hughes, the global chief executive of Deutsche Bank Asset Management, to be its president and chief operating officer in a newly created role.

George Hall, Clinton's founder, remains the boss. Hall deserves credit for being a survivor. His fund has sustained big redemptions over the past two years and almost shut down amid rumors and headlines based on an ex-employee's allegations regarding asset valuation. In two years, the fund lost more than 25% of its assets, shrinking from $11 billion to $8 billion. Last year, the SEC cleared Clinton's name and said it found no evidence of fraud.

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