HEDGE FUND NEWS
@ Mon 02 July 2007 : GMT

FINTAG COMMENT

Chaos.

While others fret about car bombs in the UK, the end of smoking, the 10th year anniversary of the Asian Crisis, the worst flooding in living memory and the ineffectual Gordon "don't make me laugh" Brown creating a government full of his mates, we look at:

the old lifers (mostly on diets it seems) who choke on their Bear Stearns arrogance;

indexation is bad for you;

hedge funds give millions away;

another fund goes bust;

and more about Bear Stearns Asset Management (which contributes only 6% to the bottom line of BS) damaging the reputation of its holding company and causing a flight to t-bills;

The Bear Stearns Announcement (pdf)

***Correction***
I may have given the impression that Amber Partners, an operational risk certification due diligence firm, had officially certified the 2 Hedge Funds that Bear Stearns Asset Management are having difficulties with. This was wrong and I apologise. Although Amber Partners is partially owned by Bear Stearns, it appears they did not use them. Strange.

Quote of the day (in 2004)
"I'm of the opinion that you need to get out and make sure your clients are aware of risk, can assess risk and are comfortable with risk. If you can get your customers comfortable with risk, they're going to buy a lot more product from you.''

Richard A. Marin, (ex) chairman and chief executive officer of Bear Stearns Asset Management, New York.

Headhunter's Watch

Bear Stearns staff looking for a way out:

Greg Quental (MeasuRisk Director and Head of Alternatives) - BSAM initiatives May 2007
Rajan Govindan (COO BSAM)
The barber between 46th and Vanderbilt (who told me this news)

FLIGHT TO QUALITY NEWS

Bear Stearns Dismembers U.S. Treasury Bear Market (bloomberg)

European Government Bonds Gain on Terror Alert, Coupon Payments

MARK TO MODEL NEWS

$250 Billion in Subprime Losses? (safehaven)

M&A-driven hedge funds thrive but see signs of peak (reuters)

Irish house prices have fallen on average by 2.1% in year to May; Prices for First Time Buyers fell by 1.8% in May (finfacts)

China's economy may grow in 2007 at fastest pace since 1995 (finfacts)

Blackstone price fall highlights research issue (financialnews-us)

McClatchy Draws Interest From Big Hedge Fund (dealbook)

Lessons of Asia's crisis, 10 years on (businessday)

Offshore Tax Breaks Lure Money Managers (nytimes)

ABX Meltdown - Tranche "A" looking rather sick

MARIN SPENDS MORE TIME WITH HIS FAMILY

Bear Stearns Hires Lehman's Lane as Head of Fund Unit (bloomberg)
Bear Stearns Cos., battered by the near-collapse of two hedge funds that forced the firm to put up $1.6 billion for a bailout, ousted the head of its asset- management division.

Jeffrey Lane, a vice chairman at Lehman Brothers Holdings Inc., will become the chief executive officer at Bear Stearns Asset Management, replacing Richard Marin, the New York-based firm said in a statement today. Lane, 65, has spent four decades on Wall Street and was CEO of Neuberger Berman Inc. until 2003, when Lehman bought the mutual fund company for $3.2 billion.

Chief Executive Officer James E. ``Jimmy'' Cayne is shaking up asset management after bad bets on bonds backed by subprime mortgages led to losses at the two funds and margin calls by rival banks. Investors, concerned that the bailout and collateral damage to the firm's mortgage business would hurt earnings, drove Bear Stearns shares down to the lowest since September.

``We'll dig our way out and emerge stronger,'' Lane said in an interview. ``None of us in this industry can get away unscathed forever. The great ones overcome the problems and move forward.''

Marin, 53, will remain at Bear Stearns as an adviser. Prior to joining the asset-management unit as CEO in 2003, Marin spent 23 years with Bankers Trust Corp. and subsequently became chairman of Deutsche Bank Asset Management.

Shares of Bear Stearns fell $4, or 2.8 percent, to $140 in composite trading on the New York Stock Exchange. They're down 14 percent for the year, the worst performance in the 12-member Amex Securities Broker/Dealer Index.

Restoring Confidence

Bear Stearns earlier this week shifted its head of mortgages, Thomas Marano, temporarily to the asset-management unit to help unwind the funds' investments. Michael Winchell, a Bear Stearns executive who served as chief risk officer in the 1990s, also moved over to assist the funds.

``They have to restore investor confidence in their funds, and they clearly need to shore up their risk-management controls,'' said Mark Batty, an analyst in Philadelphia at PNC Wealth Management, which runs about $75 billion, including shares of Bear Stearns rivals Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley. ``It's not too surprising given the fiasco they had.''

Cayne Shuffles

Cayne, 73, has been making changes elsewhere at Bear Stearns, whose 10 percent decline in second-quarter profit was the worst result on Wall Street.

In November, Bear Stearns's head of prime brokerage and clearing services, Richard Lindsey, left after his division was merged with stock trading and structured equities. Lindsey had joined the firm, the leading prime broker to U.S. hedge funds, in 1999 from the Securities and Exchange Commission.

Leonard Feder quit as co-head of prime brokerage to join Standard Chartered Plc in May, just two months after being appointed to the job. Clearing services, which includes prime brokerage, accounts for about 13 percent of Bear Stearns's revenue.

Lane, a native of Brooklyn, New York, graduated from New York University, served in the U.S. Army during the Vietnam War and received a master's degree in business from Columbia University. His first job on Wall Street was as an airline analyst in the 1960s for Cogan, Berlind, Weill & Levitt, a securities firm co-founded by Sandy Weill, who created Citigroup Inc., and Arthur Levitt, who became SEC chairman.

Not Known as Fixer

He started at the former Shearson Lehman Brothers in 1983 and later worked at Salomon Smith Barney and Travelers Group Inc. before joining Neuberger in 1998.

``He's not known as a fixer of failed things, but he'll have some fixing to do,'' said Geoffrey Bobroff, a mutual fund industry consultant.

Asset management typically accounts for less than 5 percent of Bear Stearns's revenue, compared with 14 percent at Lehman. Lane said he's used to building up money managers. When he joined Neuberger, the firm had $40 billion under management. Now it has about $135 billion, he said.

``I didn't come here to unwind an asset-management company,'' Lane said. ``I came here to grow one. I saw a great opportunity to build on what's already a successful platform, to create for Bear Stearns an outstanding, diversified asset management company.''

The two Bear Stearns hedge funds that melted down had borrowed more than $10 billion and invested heavily in highly rated pieces of collateralized debt obligations, securities that included bonds backed by some of the riskiest home loans. After the funds started to lose money, investors filed for withdrawals. Lenders including Merrill Lynch asked the funds to put up more collateral, demands they couldn't meet.

Marin's Blog

Marin included a picture from the movie ``300'' in a June 23 posting on his personal blog, saying the fictional scene from the battle of Thermopylae ``pretty much sums up my last two weeks trying to defend Sparta against the Persians hordes of Wall Street.''

Lane said he knows Bear Stearns Co-President Warren Spector personally and had talks with the firm on and off during the last five years. The discussions, which initially concerned the potential sale of Neuberger Berman to Bear Stearns, escalated in recent months, he said.

Lehman hired George Walker, a second cousin of President George W. Bush, in May 2006 as head of asset management, including Neuberger Berman. Asked whether that appointment left him sidelined, Lane said he joined Bear Stearns because he missed the ``day-to-day'' responsibilities of running an asset- management business.

OLD MAN

Salvaging a Prudent Name (nytimes)
James E. Cayne has a bellyache.



“I plan on sticking around,” said James E. Cayne, chief executive of Bear Stearns.

And it is not from the crash diet that has caused Mr. Cayne, the chief executive of Bear Stearns, to shed 20 pounds over the last year.

At Bear Stearns, the firm Mr. Cayne has worked at since 1969 and guided since 1993, the carefully honed reputation for sound risk management and cautious investing has suffered what he regards as a “body blow of massive proportion” from the near collapse of two hedge funds run by its asset management division.

“I'm angry,” he said as he took a deep puff on a freshly lit Montecristo cigar in a conference room next to his office. “When you walk around with the reputation for being the most rigorous risk analyzer, assessor, controller and that is trashed, well, you have got to feel bad. This is personal.”

In the last two weeks, Bear has found itself in a fiasco that some within the firm say is without parallel in its 84-year history.

While the unravelling of the funds is not expected to affect the bank's bottom line, it has made the firm a potential target for regulators and class-action lawyers.

Front and center is Mr. Cayne, 73, the oldest chief executive of a Wall Street firm and now confronted with salvaging the firm's reputation. He is a world-class bridge player who did not finish college and whose first job was as a travelling salesman selling copiers in the Midwest.

His ascent has been a result of a card player's guile, a brilliant run trading the distressed bonds of New York City in the early 1970s and a boundless belief in his abilities and that of his firm.

“It's an amazing story,” said Michael Ledeen, the foreign policy analyst and Mr. Cayne's bridge partner. “He didn't go to Harvard Business School — he was a bridge bum,” Mr. Ledeen said, and Mr. Cayne's predecessor, Alan C. Greenberg, known as Ace, needed a bridge partner.

“Ace said come work at Bear,” Mr. Ledeen said, “and then Jimmy made a market in New York City municipal bonds and then the frog turned into the prince.”

The problems with the two funds have shaken Mr. Cayne.

“In the last 15 years, I have never walked into a room or been at a dinner party where I did not feel that when people looked at me they thought I was O.K., successful, agile,” he said. “That might have changed. I feel like people now look at me with a question mark.”

Despite his contrition, legal experts say Mr. Cayne is likely to face tough questions from regulators and lawyers for investors over how, in a firm known for its risk controls, a trader could make such a disastrous bet.

“This is a guy that is in the loop — he is an activist C.E.O.,” said Jacob Zamansky, a securities lawyer who represents individual investors. “He can't say that he knew nothing if there is a responsibility to be on top of the different business units. The proof will be in the e-mails and the documents.”

Bear Stearns and Mr. Cayne have survived other crises. The firm has paid fines for its ties to fraudulent brokerage houses and investment firms that engaged in illegal mutual fund trading. But its scrappy disposition and a tightly knit culture that is bolstered by the 31 percent employee ownership stake have helped sustain the firm.

Until this year, the firm's stock has outperformed its peers, in part because of a dominant position in the booming mortgage securities and hedge fund services markets and a growing recognition of its influence as a niche investment banker to companies like Cablevision, Walt Disney and Verizon.

Mr. Ledeen has written a book about the leadership lessons of Machiavelli and Mr. Cayne has devoured it.

“Jimmy saw himself in Machiavelli,” Mr. Ledeen said. “He, too, is living in a world that is very corrupt and where temptation is huge. But you have to get rid of failure and you have to punish lack of virtue ruthlessly and all the time. Jimmy does not trust second chances — if he finds someone who misbehaves he gets rid of him. Fast.”

It is perhaps this sensibility that forms Mr. Cayne's extreme caution when it comes to putting the firm's capital at risk. Over the years as firms like Morgan Stanley and Goldman Sachs have become more aggressive in trading their own capital, Bear has remained conservative.

But, at the Bear Stearns asset management unit, executives started an overleveraged, high-risk fund last August just before the market for subprime loans sank.

It was the kind of high-stakes bet that the firm's own proprietary traders, wary of Mr. Cayne's exacting eye, would never have made.

And while Bear Stearns has said that the asset management unit was separate from the firm's securities division, questions remain as to why there were not adequate controls in place.

The thought of such an overleveraged bet now angers Mr. Cayne, who is the firm's largest individual shareholder with a stake that at the stock's peak was $1.2 billion.

“I would have bet against this occurring at Bear Stearns, ” he said.

That such an initiative and the attendant meltdown occurred in a business that represents but 6 percent of the firm's revenues have driven senior Bear executives to distraction.

The immediate onus has fallen on the funds' manager, Ralph R. Cioffi, and the head of asset management, Richard A. Marin, neither of whom is expected to get the benefit of one of Mr. Cayne's rare second chances.

But the business also reported to Warren J. Spector, the longtime co-president, and people inside the firm said he, too, was shouldering part of the blame.

Mr. Cayne declined to comment on who should be held responsible. But he did say that “there is a lot of pain here.”

Bear and Mr. Cayne assumed responsibility for the funds' demise by providing a $3.2 billion line of credit, a move that drew the approval of Mr. Cayne's peers on Wall Street. Still many lenders to the hedge fund wondered why the firm did not act sooner, perhaps in April when it became clear that the securities were losing value.

With its expertise in the mortgage market, lenders said the firm should have recognized a problem when these highly complex securities began to trade below their par value in the spring.

Mr. Cayne would not discuss in detail the specifics of the fund's troubles, citing client confidentiality.

Nevertheless, the view within the firm is that Bear had no legal obligation to rescue the funds and that the loan agreements made clear that the lenders were transacting with the two funds and not Bear itself. The firm decided to make the secured loan when it became clear that the funds were near collapse and that Bear's image was being damaged.

As for whether the recent turmoil might cause Mr. Cayne to step down and pass the baton to one of his co-presidents, either Mr. Spector or Alan D. Schwartz, who oversees investment banking — do not bet on it.

“I plan on sticking around and I will leave when these guys want me to leave,” he said.

Mr. Cayne shows no signs of slowing. He has cut out red wine, bacon and salmon for breakfast and the late-night deliveries from Bobby Van's steakhouse as part of a regimen to lose weight. He has a tan from weekends at his beach house on the Jersey Shore and his youthful demeanor belies his age. He is a fan of the music of the Norwegian pop star Sissel and loves any movie that stars Halle Berry.

As for any plans he might have to put the firm up for sale, he calls such talk old and repetitive and says Bear Stearns is well placed to survive as an independent entity.

All the same, the firm remains underexposed to strong growth trends overseas and overexposed to the slumping mortgage market, which contributed to a 10 percent drop in net income in the first quarter.

“The firm is doing really well, and we are expanding in Asia and Europe,” he said. “We have a phenomenal franchise.”

Leaning back in his chair, Mr. Cayne puts his foot up on a nearby chair and sighs. A man of blunt emotions, he generally feels better after a good old-fashioned venting.

No doubt, for the short term, things seem bad. Regulators are sniffing around, editorial writers are wagging a collective finger at him and, to top it all off, the head of his asset management unit has a blog.

But Mr. Cayne has experienced worse: during his days as a traveling salesman he almost died when his car hit a utility pole; he has seen a bankrupt New York City; and on the day the market crashed in 1987 he remembers walking on the floor of the stock exchange and seeing Bear's stock trading at $8 with no buyers in sight.

But Bear continues to be Bear.

“The playing field is getting small,” he said. “There are four giants and us. We are a survivor.”

CURVES

The thorny problem of how to classify a hedge fund index (ft)
Estimates of the assets in invest-able hedge fund indices vary widely, from $5bn (€3.7bn, £2.5bn) to $20bn. Since arriving on the scene in 2003, they have thrived by offering broad exposure to hedge fund net returns for 50-100 basis points, without the usual 10 per cent performance fee common for funds of funds.

Institutional allocations to hedge funds will inevitably grow, says Stephen Smith, head of funds and alternative solutions at Credit Suisse, which provides the Credit/Suisse Tremont range of indices. "Given that the asset class last year yielded something like Libor plus 3-4 per cent, if you are making your first allocation wouldn't you rather buy something like an index product that is relatively cheap?"

Indeed, reflecting the passive-versus-active debate in traditional investments, Mr Smith claims that Credit Suisse's Hedge Index Tracker product has outperformed the fund of funds universe by as much as 1 per cent annualised.

But are hedge fund indices really passive? The subject of academic debate for years, this question is now being asked in the context of consultations with the Committee of European Securities Regulators (Cesr) over whether hedge fund indices meet the three requirements for eligibility as financial indices under Ucits III.

The diversification requirement is not a problem. But do the indices meet criteria for "publication in an appropriate manner"? And doesn't a requirement to "represent an adequate benchmark" refer directly to the criticisms of statistical biases that have always plagued hedge fund indices?

"Hedge fund indices fulfil the requirements just as any other financial index," insists Margaret Gilbert, managing director at Greenwich Alternative Investments (formerly VanHedge).

But a sceptic might ask how truly passive indexing could result in the proliferation of products - more than 30 in total and at least nine investable.

Competing investable index returns can vary widely month to month, but there is little dispersion around the average 8.5 per cent annualised. And they all lag behind their respective broad hedge fund index by 3-5 per cent annually.

That is hardly surprising: out of perhaps 9,000 funds, most of the broadest indices include about 1,500-3,000 and investables tend to include about 60.

Broad indices are subject to survivorship and backfill biases that are not really issues for investables. "Some biases in hedge fund indices are found in traditional financial indices," says Ms Gilbert. "And frankly, some comments are simply inaccurate. Comments about backfilling result from confusion between data from databases versus what's calculated real-time in the index, for example."

But capacity and managed account selection biases and other, subjective selection criteria can affect investables. Then there is no consensus on whether qualitative or quantitative analysis is best for classifying a fund's strategy, or if indices should be asset-weighted, equally weighted or mixed.

Critics such as Edhec's François-Serge Lhabitant argue that this makes hedge fund indices active: "funds of hedge funds managed according to arbitrary rules", although Edhec itself supports their classification as financial indices.

"An index, like an ETF, is a different value proposition from a fund of funds," counters Ms Gilbert. "You know how the index is put together - a Cesr requirement - whereas a fund of funds manager can manage any way they want."

Perhaps the most important question is: is a product really a hedge fund index rather than a managed account index? As well as the selection bias, providers of true fund indices point to how managed accounts affect performance.

"Managed accounts are not necessarily good substitutes for hedge funds," says Winson Ho, managing director of the Alternative Asset Group at RBC Capital Markets. "Platforms built for liquidity and used for things other than indices can see frequent subscriptions and redemptions, resulting in higher transaction costs and managers having to hold a lot of cash or liquid securities. Liquidity presents challenges to us, but we have rules to handle that."

Greenwich also indexes funds, and Ms Gilbert suggests that is why it and Credit Suisse top the index performance tables.

The MSCI Hedge Invest Indices use the Lyxor managed account platform, and although Pierre Laugeri, head of hedge fund operations, accepts the liquidity/performance trade, he feels he also gains "elements that can facilitate analyses such as risk monitoring, in other words some measures of additional risk management".

Cesr's dilemma is that all this variety means different products are best placed to meet different Ucits requirements. Given a principles-based approach, most would agree that hedge fund indices should qualify as financial indices.

LAKED

Federal Court Freezes Assets of Hedge Fund in Chicago (nytimes)
A federal court froze the assets of Lake Shore Asset Management, a hedge fund firm run by a former chairman of the Chicago Mercantile Exchange, after regulators said it overstated its holdings.

Lake Shore, based in Chicago, said that it managed $1 billion for investors and traded in United States commodity futures contracts, according to the Commodity Futures Trading Commission. A review showed that the fund had about $466 million. Lake Shore barred regulators from inspecting its accounts on June 14, which is a violation of the Commodity Exchange Act, according to the commission's complaint.

Laurence M. Rosenberg is listed as Lake Shore's director, according to records from the National Futures Association, a self-regulating group for the futures industry. He is a previous chairman of the Chicago Mercantile Exchange, the largest American futures exchange. Lake Shore had been profitable 13 years in a row, the trading commission said.

The commission froze $228 million of investors' money at Lake Shore, according to a spokeswoman, Ianthe Zabel.

“The commission's ability to inspect books and records is a critical regulatory tool that allows us access to a registrant's daily operations,” Gregory G. Mocek, the commission's head of enforcement, said in a statement.

Lake Shore is a commodity pool operator, a type of investment group that seeks to aggregate money to trade futures and options on commodities and other financial instruments. There were 1,898 such groups in 2004, with a total of $594 billion in net assets, according to the commission.

The commission's complaint contends that Mr. Rosenberg and others at the fund gave inconsistent statements to regulators regarding the fund's activity and that it has refused to make documents available to the agency.

On June 14, Mr. Rosenberg allowed the National Futures Association to review Lake Shore's protected Web site, where it discovered the fund had $466 million in managed accounts, “dramatically less than Rosenberg's estimate that L.A.M. had approximately $1 billion under management,” the commission said, referring to the fund by its initials.

A hearing on the matter is scheduled for July 11, the commission said.

Mr. Rosenberg did not return a call for comment. Drew Mauck, a spokesman for the company, declined to comment.

Mr. Rosenberg served as a Chicago Mercantile Exchange director from 1970 to 1993 and held chairman or vice chairman positions there between 1974 and 1988, according to filings with the Securities and Exchange Commission. He also was a legislative liaison for the Chicago exchange in 1989 and 1990 and a senior policy adviser in 1991.

Lake Shore's parent company, the Lake Shore Group of Companies, has clients in more than 40 countries and offices in Chicago, Bermuda, Hong Kong and London, according to press releases issued by the company this year.

Judge Blanche M. Manning of the Federal District Court in Northern Illinois granted the commission's request to freeze Lake Shore's assets and to prevent it from destroying documents related to the inquiry, according to a court filing dated Wednesday.

Judge Manning ruled that Lake Shore “has engaged, is engaging in and is about to engage in violations” of the Commodities Exchange Act and granted the restraining order on the fund “to preserve the status quo and to protect public customers from loss and damage.”

TAX ME

Expert View: London leads the world - let's not throw it away (independent)
Has Mr Brown noticed the link between success and low tax?

London is getting just about everything right. Society is open, business is a meritocracy and the culture diverse and liberal. The cluster effect is weaving its magic to spark innovation and creativity. The tax climate is benign for foreigners stopping to do business. Regulation is light, apposite and principle-based. Labour law is flexible.

We are a mix of everything New York, Tokyo, Paris and Frankfurt would like to be. We have become the world's international financial centre.

What is there still to learn? The US has proved remarkably adept at throwing away its lead. Its politicians failed to see that outdated domestic laws would drive business away. The euro- dollar market was created in London in the early 1960s because US legislators did not change the archaic laws that stopped banks from doing in New York what they found they could in Europe. Banks couldn't pay interest on overnight deposits in the US, but could in London and Paris. Once the market had moved from New York, no change in legislation would ever bring it back.

Financial history might have faded from memory, so the Yanks did it again in 2002 with the Sarbanes-Oxley Act, which imposed onerous obligations on directors of listed groups and instantly made the US stock exchanges unattractive for both American and international players. A stampede to London began. Wall Streeters are still trying to corral share listings for Nasdaq and the NYSE, but even if US politicians and regulators finally recognise that finance is a global competition, it might be too late to bring the game back to town.

Two areas that are still dominated by America are private equity and hedge funds. Both are largely unregulated in the US and tax there is benign for both industries. Carried interest (a performance-related fee for partners) is taxed at 15 per cent in the US and hedge fund managers are allowed to defer paying it by leaving their fees in the fund - in effect, reinvesting their profit without paying tax. Have the US politicians worked out that there might be a correlation between success on the international stage, low tax and light regulation? Has Prime Minister Brown?

Is there anything else that has helped London to leave rivals trailing in its wake? It can't be communications; they are taken for granted everywhere in the developed world. That said, it's handy everyone here speaks English. But we mean it when we say "welcome", and I'm not sure the same can be said for bien-venue and Willkommen.

Perhaps it's also that the odds are stacked against foreigners in New York, Paris and Frankfurt. US politicians pulling the plug last year on the Dubai ports deal, German politicians and trade unions stymying the private equity "locusts" and French restrictions on foreigners buying businesses - all exemplify a parochial approach that only undermines these centres.

Or it could be that the value of specialisation - the deep understanding of complexity and knowledge derived from personal contact - attracts people to where these things can be found. Information residing in machines can be accessed any-where, but real talent is human capital which is mobile and will gravitate to the hub. Talent will also go when it's time to be gone.

And the time to go is when London is no longer a compelling destination for foreigners. If the Government gets even one big thing wrong - like discriminatory taxes (the threats against private equity spring to mind), over-regulation or protectionism - there is a real risk the mobile talent will flee. If Gordon Brown thinks he can call the City's bluff on any of these, it will be cold comfort if the last person to go can say "we told you so" before turning off the lights.

GIVING

£230m donation to charity (times)
A hedge fund owner gave £230 million to his charitable foundation last year, one of the largest individual acts of charity by a Briton.

The donation, by Christopher Hohn, 40, the founder of the Children's Investment Fund, has pushed receipts for the fund's foundation — run by his wife — past the $1 billion mark less than five years after it was set up. He gave £50 million the previous year. The size of his donation is said to be the result of the phenomenal returns he has generated for investors in the fund, otherwise known as TCI.

TCI rose to prominence two years ago when Mr Hohn blocked Deutsche Börse's bid for the London Stock Exchange. It was also TCI pushing for a shake-up at ABN Amro that led to a €71 billion battle for the Dutch bank. The TCI foundation finances projects for children in the developing world.

CAT IN THE BAG

Hedge fund sheep in wolves' clothing (ft)
Have black box model, backtest data excellent, am expecting to earn a billion dollars a year, send your money now (minimum $1m, one year lockup).

The aspirants are many, but the successful are very few in number. In fact, say the critics, the world of hedge funds is too much characterised by false and misleading claims and inappropriate remuneration structures.

For some years hedge fund statistics have been regularly churned through the analytical models of academics who hope to prove that the funds' returns are not quite what they seem. There are, allegedly, too many sheep in wolves' clothing. The argument is all about what is alpha, or the excess return achieved through skill, and what is beta, which can be easily harvested from financial markets.

Who cares when it is surely the total returns that really matter? Well, it is all about fees. Genuine alpha is worth a lot to return-starved investors. It certainly merits the standard 2/20 fee structure, and the best funds charge substantially more. Beta, on the other hand, is a commodity item worth only a few basis points.

Last month Barclays Capital was the latest investment bank to come out with a hedge fund replication index. The idea is to get close to the performance of a basket of actual hedge funds. Barcap is trailing behind a number of earlier versions from the likes of Merrill Lynch, JPMorgan and Goldman Sachs, but not surprisingly it claims its version is more sophisticated.

Not only will it be possible to use Barcap's impending model to obtain most of the hedge fund return, but actual hedge fund investors will be able to go further. By shorting the index they will be able to hedge their hedge funds and eliminate all that irritating beta while safely capturing the precious pure alpha.

Professors were busy in London last week pronouncing on the hedge fund clone debate. Narayan Naik, of the London Business School's BNP Paribas Hedge Fund Centre, spoke of the coming squeeze on the sector. "Fees are a drag on returns in a diminishing alpha environment," he warned. Only the best would survive but their fees would go up, he added.

On the other hand, Edhec's Lionel Martellini outlined the French business school's research showing that replication is still too inexact to be useful. It is what high-charging hedge fund managers must be keen to hear.

In general, though, hedge fund returns have been unexciting. It was interesting that last Wednesday's Merrill Lynch/Capgemini World Wealth Report 2007 on high-net-worth individuals showed a sharp fall in allocations last year to alternative investments (private equity apart).

Instead, the managers of rich investors' portfolios have been shifting assets into real estate funds, which have been delivering much higher returns - for the time being, anyway. Still, hedge fund performance has picked up a bit in 2007 so far (though the June numbers, when they arrive, may show damage from the bond and credit markets).

There are pressures on fading models and strategies. The real test for sustainable alpha generation comes when adjustments have to be made to suit changing circumstances. Remember that a great moneymaking idea was to package low grade debt in complex structures, re-rate it and then leverage it heavily. But now Bear Stearns, and a great many others, will have to think of something else.

Mr Naik argues that the big "macro" opportunities of the past, such as mispriced currencies (as on Black Wednesday) and the great euro bond convergence trade, have disappeared. There is still one left on the table, in the form of the yen carry trade, but it may have only a short shelf-life remaining. This leaves most hedge funds forced to focus on narrow market opportunities using trading strategies that, in many cases, can be cloned quite cheaply.

Alpha has been in short supply. During 2004 and 2005 only 5 per cent of funds of hedge funds delivered statistically positive alpha to their investors (and the average fund of funds delivered none at all) according to a forthcoming academic paper.

We know from the long-only sector, where alpha is more easily measured, that disappointing performance over many years has caused a large-scale switch by investors to passive products amid allegations of closet indexing and a proliferation of risk control techniques.

When the costs of active management outweigh the benefits investors go passive. It could now be the turn of hedge funds to suffer.