Hi Ted,

I think you hit the nail on the head: "if the market were efficient in allocating capital," I don't think it would be going to hedge funds.

One of the key assumptions of Efficient Market Theory is that investors are fully informed. If investors were fully informed (and fully rational, another key assumption), then they would make use of the evidence showing that hedge funds have been poor for a long, long time, and they would get out. The fact that capital is still flowing in to such a poorly performing asset class can be taken as evidence that investors are not fully informed, and therefore that markets are not efficient.

More seriously, one of the basic problems with hedge funds (and private equity, including private equity real estate) is that asset values are not properly measured, making them appear to have less volatility than they really do. Again, investors are not fully informed as to the riskiness of their investments in hedge funds (and private equity). Basically, the "best and the brightest" have discovered that they can systematically take advantage of investors' lack of information to extract extraordinarily high fees for the "service" of making investments appear to be less risky than they really are.

Yes, that's smart--but it's not good investment management.