There is no greater evidence of the phenomenal growth of hedge funds than this: There are now nearly as many of them as there are mutual funds.

These investments -- lightly regulated private funds that often take high-stakes, highly leveraged positions in securities -- were originally created for high net worth and institutional investors. But now, aiming to capitalize on the huge popular fascination with them, many hedge funds are increasingly targeting less-sophisticated investors as well.

Firms from Citigroup Inc. to Merrill Lynch & Co. are jumping in with new offerings that have investment minimums as low as $25,000 -- a far cry from the traditional minimums of $250,000 or more. Such offerings are part of a larger category of so-called funds of hedge funds, which bundle stakes in different hedge funds into one -- theoretically safer -- investment. Aimed in part at smaller investors, funds of hedge funds now account for about 30 percent of all hedge-fund assets. There is even an emerging category of "funds of funds of hedge funds" -- sometimes called F3s -- that aim to pick the best-performing funds of funds.

The risk is that this could be precisely the wrong time for smaller investors to get into hedge funds. Efforts to broaden their ranks come as some economists are questioning whether the stellar overall gains of hedge funds can be sustained. Hedge-fund returns, which were in the 20 percent-plus range a decade ago, have moved closer in line to more staid stocks and bonds, according to a report released last year by J.P. Morgan Securities, a unit of J.P. Morgan Chase & Co. In addition, some of the newest fund of funds add layers of extra fees -- the total being as much as 3 percent of assets, a 1 percent to 3 percent sales fee, plus 30 percent of profits -- that can drastically cut into performance.

"The hedge funds want to get access to traditional mutual-fund investors because there's a lot of money there," says Tobias Levkovich, chief U.S. equity strategist at Citigroup's Smith Barney unit. But, he adds, individual investors have been historically late to investment trends.

Those in the business say the sector is going through the growing pains of any rapidly expanding, maturing industry: Skilled managers will survive, and bad funds will quickly go out of business. Some blame the weaker returns on the massive inflow of money into hedge funds in recent years, which is causing more funds to compete for the same or similar investment opportunities.

But there are other challenges as well. One of the biggest is that there is no regulatory body with the authority to verify that hedge-fund returns are accurate. Unlike mutual funds, which must report their periodically audited results to regulators and investors, most hedge-fund performance is reported voluntarily.

Most of them today aim to provide investors with performance data on a regular basis. Some hedge funds, for example, report their performance based on guidelines developed by the CFA Institute, a nonprofit group representing asset managers and financial analysts based in Charlottesville, Va. But the way in which hedge funds report and calculate returns varies.

Partly to assuage such concerns, some -- but far from all -- funds of hedge funds are registering with the Securities and Exchange Commission. That requires the fund to file financial reports, limit their borrowing, and elect a board of directors to provide independent oversight of the fund's operations, including valuation of its assets. Though generally not legally required, an SEC registration often allows the fund to take in more investors, which typically enables it to lower its investment minimums. Investors still need to meet the same requirements for net worth (at least $1 million in investable assets) and annual income (typically $200,000 or more) as they would for traditional hedge funds.

In one of the most notable drops in minimum investments, Charles Schwab Corp. has introduced a new share class for its Hedged Equity Fund, allowing people in who pony up as little as $2,500. Previously, the minimum was $25,000. There are no net-worth requirements because the fund is technically a mutual fund, though it follows hedge-fund techniques such as short selling, or betting that the value of a security will fall.

Some hedge-fund strategies, such as using borrowed money to amplify returns and making other unorthodox moves that can help in flat or down markets, present risks that individual investors may be ill-prepared to take. These risks, as well as those posed by the light regulation of hedge funds, have been borne out recently in some high-profile cases.

In February, the SEC accused three partners of Northshore Asset Management LLC, a Chicago-based hedge fund, of improperly putting $37 million of investor money into hard-to-trade stocks. The next month, KL Financial Group, a Palm Beach, Fla.-based hedge fund, was shut down amid an investigation that the fund reported outsize returns while it was losing money. Overall, in the five years through 2004, the SEC brought 51 cases against hedge-fund advisers who, it asserted, defrauded investors of more than $1.1 billion.

Firms are rolling out some new ways to invest in funds of hedge funds, some of which are aimed at smaller investors. Here are three of them:

Registered funds of funds

In recent years, some of the world's biggest hedge-fund players, including UBS AG and Man Group PLC, have rolled out registered funds of hedge funds with lower minimums. On April 1, CSFB's Hedge Fund Investments group, a unit of Credit Suisse Group, launched five funds of hedge funds with minimums of $50,000. Although individual investors can invest in the funds, the company says the primary motivation for registering them was to be able to accept more pension plans. John Kelly, the president of Man Investments Inc., a unit of Man Group, says its registered products are targeted to reach the "mass affluent" individuals with a net worth of between $1.5 million and $10 million.

Investors typically have more protections with hedge funds that are registered with the SEC. For one, registered funds must generally maintain required books and records, submit to periodic examinations by the SEC's staff and use less leverage. They also generally have less discretion in valuing securities.

Under new rules slated to take effect in February, more hedge-fund advisers will be required to register with the SEC, open their books to federal examiners and designate a chief compliance officer -- all of which should lead to fewer cases of misreported returns, says Robert Plaze, associate director in the SEC's Division of Investment Management.

Funds of funds (of funds)

Funds that group stakes in various hedge funds -- and thereby attempt to reduce the risk of investing in any one fund -- have been growing in size and popularity. The newer funds of funds of funds, or F3s, are being billed as an even safer version of funds of funds. They're just beginning to become available to U.S. investors, although they are offered more widely overseas. F3s typically aim to create a diversified basket of strategies by buying top-performing funds of funds that each specialize in a different strategy, such as equities or fixed income.

One big problem with most funds of hedge funds is that their high fees inevitably cut into performance. Regular hedge funds typically charge between 1 percent and 2 percent of assets and as much as 20 percent of profits. Investors in funds of funds can often end up paying an additional 1 percent of assets and 10 percent or more of profits. Many of the newer breed of registered funds of funds also charge a sales fee of between 1 percent and 3 percent. According to a recently published study in the Journal of Investment Management, investors may actually pay out more in fees by investing in funds of hedge funds than they earn in returns.

While funds of hedge funds defend their fees as a fair price for access to the best managers, annual returns for funds of hedge funds typically lag behind those of the broader hedge-fund industry. Last year, the HFRI Fund Weighted Composite Index -- which relies on data supplied by hedge funds to measure their performance as a whole -- posted gains of 9.05 percent, compared with total returns of 10.87 percent for the Standard & Poor's 500-stock index. Funds of hedge funds gained 6.81 percent.

Accurately calculating returns is a particular problem for funds of funds, since -- in order to figure out their own returns -- they must combine the returns of the underlying hedge funds they invest in. Lacking access to those portfolios, they may find it difficult to independently verify the data. However, because many of the larger funds of funds cater to institutional investors, they have been able to extract better information about returns, the SEC's Mr. Plaze says.

Hedge-fund indexes

Another approach aims to offer investors a way to get instant diversification across the hedge-fund industry, often at a lower cost than funds of funds. Known as investable hedge-fund indexes, these products, like other market indexes, passively track the performance of selected managers. These products appeal to institutions and other risk-averse investors because the index providers require that participating hedge funds agree to provide regular information on their trading.

About half-a-dozen investable indexes have been launched in recent years, including ones run by Standard & Poor's, a unit of McGraw-Hill Cos.; Van Hedge Fund Advisors International LLC; CSFB/Tremont Index LLC; HFR Asset Management LLC; and Morgan Stanley's MSCI unit. Critics say the investable indexes post lower returns than the broader hedge-fund industry because first-rate hedge funds aren't likely to agree to the reporting requirements necessary to be included in the index.

New Ways to Play

As hedge funds rake in assets, investors have more options:

Hedge-fund indexes: Lower-cost baskets of hedge funds that passively track a broader index

Market-neutral funds: Mutual funds that mimic hedge-fund strategies and typically have no net-worth requirements

Funds of funds of funds: Funds that invest in funds of hedge funds -- and have three layers of fees

Registered Funds of Hedge Funds

The hedge-fund industry is attempting to reach out to a bigger pool of investors by introducing new funds of hedge funds registered with the Securities and Exchange Commission. These funds also have lower minimums than nonregistered funds of hedge funds, and boast an additional level of disclosure and regulatory oversight by the SEC, which oversees their returns. Investors, however, still generally have to meet certain net worth and income requirements.

Here are six registered funds of hedge funds with low minimums with assets and net returns for the year ended Dec. 31,2004.
FUND NAME	MINIMUM INVESTMENT	ASSETS (millions)	2004 NET RETURNS
BNY/Ivy Multi-Strategy Hedge Fund LLC	$100,000	$133.1	6.71 percent
Citigroup Alternative Investments Multi-Adviser Hedge Fund Portfolios LLC (Multi-Strategy Series G)	25,000	207.9	5.75
Man Glenwood Lexington LLC	25,000	93.5	1.80
Oppenheimer Tremont Market Neutral Fund LLC	50,000	73.0	1.86
Oppenheimer Tremont Opportunity Fund LLC	50,000	85.0	3.37
Rydex Capital Partners SPhinX Fund	25,000	258.0	1.78
Source: SEC filings the companies