HEDGE funds are being blamed for just about every ill of the financial markets in 2007.Aggressive, unregulated and secretive, these powerful investment pools employ any strategy they wish to try to make money for high-net-worth individuals unafraid of risk.

Their philosophy of going against the grain also has produced some side effects that are altering banking and personal investing:

l They’ve picked up risky business that would otherwise be imploding on bank balance sheets.

l Everyday investors, desiring a piece of the hedge-fund pie for less money, are moving assets into long/short mutual funds.

Congress, viewing collapse of the subprime lending market with alarm, is concerned about the involvement of hedge funds in the collateralised debt obligation market. Yet some experts consider that a positive hedge fund influence.

“The hedge funds and their rich clients are taking over significant risk that would otherwise fall on the banking system,” said Stephen Brown, a finance professor at New York University’s Stern School of Business. “They are clearly providing a conduit through which risk is being diverted from the public.”

Nonetheless, hedge funds do themselves a “tremendous disservice” in the eyes of both regulators and investors by not being more forthcoming with financial information, and that means “the sins of the few will be visited on the many,” Brown said.

Hedge funds are playing an increasing role in international banking.

“In the last 10 years, the dollar-yen trade has been an extraordinary investment for hedge funds and Japanese banks because they could borrow yen cheaply, invest in US Treasuries with a 5 percent spread and leverage with little risk,” said Charles Gradante, managing principal with the Hennessee Group LLC in New York, a consultant to hedge fund investors. “This definitely helped Japan refinance its banking problems.”

For individual investors, the primary way hedge funds have made a difference is that investment firms have been encouraged to offer types of funds that travel apart from the herd. With high investment minimums aimed at millionaires only increasing at hedge funds, they’re getting further and further out of reach for most investors.

As a result, the long/short mutual fund is capturing the lower end of the market for investors seeking diversification of their holdings.

A long/short mutual fund employs some of the trading strategies of hedge funds, such as leverage, derivatives and short positions, to maximise returns regardless of overall market movements. Their short selling, a way to make money when a stock goes down, involves selling a stock you don’t own or a sale completed by delivering a security borrowed by the seller.

Long/short funds generally have higher fees and less liquidity than other mutual funds and aren’t permitted to be as adventuresome as hedge funds. But they offer reasonable minimums and serve the function of an alternative investment in a personal portfolio, as a hedge fund does.

“During the market correction of February 27, mutual funds were down about 3 percent, but long/short funds were down only 1 percent,” said Ryan Tagal, director of hedge funds and alternative investments for Morningstar Inc.

A study of the latest 13-year market period by Lipper Inc. found neither hedge funds nor long/short funds have any correlation to either the stock or the bond markets. They therefore offer investors protection from downdrafts in the other markets.

“What makes a long/short fund unlike a normal mutual fund is the notion of using short positions as a way of adding value, since most mutual funds are long only,” said Harindra de Silva, president of Analytic Investors Inc. in Los Angeles. “This year there is a large discrepancy between the best-performing stocks and the worst, which provides us an opportunity to add value.”

The $125 million Old Mutual Analytic US Long-Short Fund “Z,” (OBDEX), co-managed by de Silva, has a 12-month annualised return of 17 percent to rank in the top 1 percent of long/short funds. More important, its results surpassed the Standard & Poor’s 500 index by 9 percentage points for that time period.

Its three-year annualised return of 13 percent places it in the top 8 percent of its peers. The return is 3 points higher than the performance of the S&P 500. This “no-load” (no sales charge) fund has a minimum initial investment of $2,500 and annual expense ratio of 1.27 percent.

“You can see what’s in our fund, though we don’t tell people what we are short until two months afterward,” said de Silva. “Our minimum is low, the price of the fund is set every day by the administrator, and you benefit from having a lot of mutual fund structure around it that you don’t have with a hedge fund.”

Here from Morningstar are long/short funds — just watch those expense ratios — with some of the strongest returns:

l The $111 million-asset TFS Market Neutral Fund (TFSMX), no load; $5,000 minimum; annual expense ratio 2.49 percent; no three-year return yet; one-year return 17 percent.

l The $135 million-asset Caldwell & Orkin Market Opportunity Fund (COAGX), no load; $25,000 minimum; annual expense ratio of 2.05 percent; three-year annualised return of 5 percent; one-year 15 percent.

l The $690,000-asset Georgetowne Long/Short Fund (GTWNX), no load; $5,000 minimum; annual expense ratio of 1.99 percent; three-year annual return of 10 percent; one-year 11 perc.

(Andrew Leckey answers questions only through the column. Address inquiries to Andrew Leckey, P.O. Box 874702, Tempe, Ariz. 85287-4702, or by e-mail at andrewinv<$>[AT]aol.com.)