Wow. I don't disagree with your argument that "the best and brightest spend their time where the compensation is best, and today in the public markets, that’s clearly in the hedge fund universe" (except that compensation is pretty darn good in private equity, too) but there's a pretty basic flaw in applying that to investment management: the compensation that goes to the hedge fund (and private equity) managers does NOT go to investors.
Just look again at the CEM Benchmarking results. On the basis of returns gross of investment costs, hedge funds were not the worst asset class: their 6.02% per year average beat out U.S. Other Fixed Income at 5.29% per year--but their tremendously high investment costs (driven mostly by tremendously high compensation!) brought them down below everybody else on a net returns basis. (Similarly with private equity: they were the top asset class in terms of net returns: it was their tremendously high investment costs that brought them below listed equity REITs on a net returns basis.)
If I were among the best and the brightest, I would do the same thing: go to where I could reliably get tremendously high compensation even if I delivered consistently lousy returns. It must be just the stupid people who focus on producing good returns for their investors rather than for themselves.