Slate – This was the year of hedge funds. The largely unregulated pools of private capital—generally available only to institutions and the rich—have proliferated nearly as fast as adulatory articlesabout them. Hedge-fund managers have historically been the Garbos of the asset management world: They want to be left alone by the media, by the public, and above all, by the Securities and Exchange Commission. But in recent years—and especially in 2005—they’ve had a coming-out party. Aggressive hedge-fund managers are seeking to shake upmanagement and push restructurings at blue-chip companies like Time Warner and McDonald’s. Others, not content to flip stocks, have taken the reins at well-known companies, as Edward S. Lampert has done at Sears.

As the chart accompanying this article shows, the hedge-fund industry has doubled in the last four years; there are now an estimated $1 trillion in assets in 8,000 funds. Staid institutions like university endowments and state employee pension funds are plunging cash into hedge funds. And investment banks have rolled out funds that allow merely well-off people to invest in them.

Are hedge funds the next big thing in mass investing? And if so, will they suffer the same lousy fate as the last big thing in mass investing—mutual funds? In the 1990s, the mutual-fund industry doubled. Millions of new investors, lured by excellent recent performance, thronged into funds. Today, according to the Investment Company Institute, there are 8,000 U.S. mutual funds with $8.5 trillion in assets. Yet every year, the majority of them underperform broad market indexes—and charge fees for doing so. It turns out the mutual-fund industry expanded well beyond the ability of mutual-fund managers to run the money effectively. Today, mutual funds are a clunky business that relies heavily on marketing, survives on management fees, and fears new competitors.

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