FIVE minutes ago, advisers barnacled to the investment industry were championing hedge funds as balm for the swollen deficits afflicting pension funds. Now, the purveyors of contradictory counsel have decided hedge-fund investments are more placebo than panacea.At a two-day conference in London last week, the backlash was in full swing as more than 200 attendees pondered the merits of “Hedge Fund Replication and Alternative Beta”. While the two-part title won’t win any awards from the Plain English Campaign, it sketches a possible solution to the current disenchantment with the former market paragons.

The concept is seductively simple. Is it possible to reproduce a hedge fund on the cheap, duplicating the strategies and stellar returns without giving away fees worth 2 percent of the initial investment and 20 percent of the profit?

The easiest way to try and get your head around the cloning concept is to consider how a merger-arbitrage fund operates. Its investment style is easy to understand: Buy the stocks of companies being bought, which typically gain, and sell short the stocks of acquirers, which typically decline.

A rule-based system would copy that strategy and “capture almost all of the return”, Bill Fung, a professor at the BNP Paribas Hedge Fund Centre of the London Business School, said at the conference.

While other market systems are more complex, they too can be broken down into discrete variables — volatility, credit risk, correlation, timing — that can be corralled into a set of securities to mimic hedge-fund performance. Well, that is the claim, anyway.

Much of the modern debate about how best to play the financial markets focuses on two letters from the Greek alphabet: alpha and beta. Beta represents what you get simply for having some skin in the game — owning the 30 stocks in the Dow Jones Industrial Average in the proportion they appear in the index, for example. Alpha is the excess return you make by being clever — scaling back your investment in Caterpillar Inc., say, to boost your holdings of Boeing Co.

The charge against hedge funds is that they levy outsized fees on the pretence of generating tons of clever alpha, when they are really just seizing the beta available to anyone. The evidence includes the lack of what investment advisers call persistence; in the $1.4 trillion industry, it is hard to find anyone who beats benchmark indexes year in, year out.

Fung estimates that just 5 percent of funds generated “statistically positive alpha” in 2004 and 2005, down from 21 percent from 1995 to 2003.

As more money has poured into hedge funds, there’s less juice available both to the newcomers and the old-timers. When profit opportunities are scarce, high fees destroy returns. While the fees and costs associated with buying into a hedge fund are fixed, “the investment opportunities are variable,” Fung said.

Once you embrace the idea that there’s not really any alpha to capture, you are ready to consider visiting the world of so-called alternative beta to swell your returns.

Depending on how adventurous (or desperate) you are, you might consider exotic currencies; specialised insurance risks such as hurricanes or life policies; collectibles, including art and antiques; or environmental plays involving carbon-dioxide permits or weather derivatives. Romek Pawlowicz, who runs London-based Orthogonal Partners, sketched a scenario where a fund invests in a teenage soccer star, expecting the player’s value to peak in his late 20s.

The fund might take a slice of his annual earnings as a dividend, and would be entitled to a chunk of any transfer payments when he switched clubs. I’m not sure I want my pension riding on the vulnerable skeleton of a young athlete.

Hedge funds bounced back in the fourth quarter to post their best year in three in 2006. Returns climbed to 5.78 percent in the final three months, up from 1.27 percent in the third quarter, 0.78 percent in the second and 5.46 percent in the first, according to an index of more than 3,000 funds compiled by Credit Suisse Group and Tremont Capital Management Inc.

That boosted the average annual return to almost 14 percent, beating 7.6 percent in 2005 and 10 percent the previous year, though trailing gains of more than 15 percent in 2003.

Still, you would have done better with a stock-market index-tracking fund. Including reinvested dividends, the S&P 500 Index gained almost 16 percent last year, as did the Russell 3000 Index. The Dow Jones Industrial Average returned more than 19 percent, while in Europe the Dow Jones Stoxx 600 Index delivered almost 18 percent.

“Fees in hedge funds are ridiculous, period,” said Harry Kat, professor of risk management at London’s Cass Business School. “I’m not saying these managers don’t have any skill; they just don’t have enough to justify their fees.”

If it is possible to produce hedge-fund-style returns with a rule-based strategy, surely there is a temptation to sell those products with accompanying fees that are at or near current levels. Why would you give those returns away more cheaply?

Hedge-fund managers seem to be victims of their own success. The money they have attracted and put to work has surely contributed to reduced volatility, disappearing credit spreads and waning investment returns. If their fees are so exorbitant in relation to the uncertainty of their ability to add value, the invisible hand of market forces will do its work.

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)