On the eve of the SEC's Sept. 15 deadline for comments on whether hedge funds should be required to register, Hennessee Hedge Fund Advisory Group of New York has issued its 10th annual hedge fund study, once again claiming they are not the wildly risky investments that they are made out to be. Nor, Hennessee claims, are hedge funds a threat to the financial system.

As proof of hedge funds' relative conservatism, the study pointed out that 85% of these funds have never leveraged more than two times capital and that portfolio turnover averages about 300%. Meanwhile, hedge funds have generated an annualized return of 15.34% with 40% less volatility than the S&P 500 return of 12.11% over the same time period, the study said.

Not all are convinced. Gifford Lehman, of Gifford Lehman Advisory Services in Pebble Beach, Calif., said the lack of transparency in hedge funds increases their risk. He recalled one hedge fund manager who embezzled from his own fund and then gambled the money away. "Even though there was a Big Eight accounting firm watching the books, they didn't catch it in time, and it was too late," he said. Lehman was also doubtful about the performance numbers, since they don't reflect survivorship bias. "Every time I look at the performance of individual funds," he said, "the stated return is always below the expected return."

The study also found that individuals and family offices continue to represent the largest source of capital for hedge funds, holding 44% of industry assets, while funds-of-funds are the fastest-growing source of capital for hedge funds, with assets up 810% since January 1997 to $191 billion. Still, on perhaps a more worrisome note, assets in pensions that invest directly in hedge funds have grown 453% since January 1997 to $72 billion.

Oddly enough, although many industry observers have noted that hedge funds have been racing to register in the past year or so in order to preempt any rulemaking, this year's Hennessee study found that the percentage of hedge funds registered with a regulator had fallen to 58% from 75% in 2002. Those registered as RIAs had also fallen to 48% from 50% in 2002.

David Lewis, president of Resource Advisory Services of Knoxville, Tenn., said hedge funds provide important liquidity to the market but needs to be held accountable.

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