By DONNA ROSATO

Published: June 2, 2002

HEDGE funds claim to have been among the few bright spots in the investment world the last two years. But just how well these alternative investment vehicles stack up against stocks, bonds and mutual funds is difficult to gauge, because there is no generally accepted benchmark for measuring the performance of the nearly 6,000 hedge funds now operating around the world.

Standard and Poor’s, the McGraw-Hill division that operates indexes like the S.& P. 500, hopes to change that. The company plans to start its own hedge fund index early this summer, and says it will provide a transparency now absent from the industry.

The new index, S.& P. says, will represent the entire universe of hedge funds, even though it will initially track the returns of only 40 funds. That has drawn some skepticism from hedge fund managers — as well as from companies that operate rival indexes and base their data on hundreds of funds.

»This is a difficult thing to get your arms around,» said Andrew Serotta, a hedge fund manager in Scarsdale, N.Y. for SITE Capital Management, which has $40 million under management. »There are so many hedge funds out there that use so many different investing strategies.»

Standard & Poor’s says its statistical research shows that 30 to 40 funds reliably reporting their performance data can accurately represent a much larger universe. »We think there are more investors who might be active in hedge funds if they were able to get better information,» said Paul Aaronson, executive managing director for portfolio services at S.& P. and the head of the team developing the index.

It is not clear how precisely any index can track the secretive world of hedge funds, those loosely regulated investment partnerships that use complex strategies like short-selling, arbitrage and derivatives. Traditionally aimed at the very wealthy, hedge funds have been lowering investment minimums recently. The funds are not required to disclose their holdings or performance, and many never report their results.

»A large player like S.& P. will bring more validation to this industry,» said Jeff Joseph, managing director at HedgeWorld Markets, a broker of hedge funds. »A benchmark helps the industry increase its visibility and gives advisers and investors more tools to gauge their investments. But the devil is in the details.»

Standard & Poor’s joins a growing list of companies that want to become the authority on hedge fund performance. They already include Credit Suisse First Boston Tremont Indexes, a joint venture of Credit Suisse First Boston and the Tremont Advisers unit of OppenheimerFunds; Zurich Capital Markets, the New York division of Zurich Financial Services of Switzerland; Van Hedge Fund Advisors International of Nashville and the Hennessee Hedge Fund Advisory Group of New York.

Morgan Stanley Capital International, which is controlled by Morgan Stanley Dean Witter, is also planning to launch a series of hedge fund indexes by the end of the year.

Some of the existing indexes track a specific investing strategy, while others follow the overall hedge fund market. But because of the fragmentary nature of the available data, not one is widely accepted as a benchmark, said James R. Hedges, president of LJH Global Investments, a hedge fund advisory firm in Naples, Fla.

THE development of indexes reflects the growing interest in hedge funds. Investors seeking an alternative to poor returns in stocks, bonds and mutual funds poured a record $243 billion into the industry since 2000; it now has $560 billion in assets.

The funds are also drawing increasing scrutiny. Last week, Harvey L. Pitt, the chairman of the Securities and Exchange Commission, said that he was concerned about possible hedge fund fraud, and that the agency was considering tougher reporting requirements and restrictions on fees.

In addition to putting together the index, S.& P. is licensing the rights to develop investment vehicles tracking it to PlusFunds, a New York company that provides data on hedge fund performance to institutional investors. Christopher Sugrue, the chairman of PlusFunds, said it would begin offering S.& P. index hedge funds this summer to big investors like insurance companies and banks. Such funds are also planned for wealthy individuals, he said.

Other companies are already offering investments that track their hedge fund indexes. In September, Credit Suisse First Boston started an offshore fund based on its CSFB/Tremont Hedge Fund Index; Zurich Capital offers index-tracking funds to pensions and endowments. At Van Hedge Fund Advisors, index hedge funds are in the development stage.

In some ways, funds that track a hedge fund index resemble the stock index funds offered by many mutual fund companies. Both are based on strategies that use mathematical means to represent the movement of underlying markets.

But there are substantial differences. Traditional stock index funds mirror a marketplace that is relatively open and priced daily. Hedge funds, however, are generally open only to the wealthy; the shares are priced intermittently and those represented in indexes may be sold only quarterly.

Standard & Poor’s has not disclosed its method for making its index more widely representative of the hedge fund market. Its tracking of only 40 funds initially, its competitors say, puts it at a disadvantage.

»Our indexes are very broad-based,» said Robert Schulman, co-chief executive of Tremont Advisers, which helps operate the CSFB/Tremont Hedge Fund Indexes. »We represent hundreds of managers, while S.& P. will only have 40.»

S.& P. has also not yet identified the funds it will be using. Albourne Partners, a hedge fund consultant in London, is reviewing them, S.& P. said, and will make sure that they adhere to their particular investing strategies. Each has agreed to accept up to $100 million for investments from index-linked funds, it said. If a fund in the S.& P. index closes to new investors, it may be replaced in the index. In some cases, an additional fund with the same strategy will be added, raising the total of funds in the index.

THE funds in the S.& P. index will report performance daily, the company said, far more regularly than most hedge funds do. The funds will have an equal weighting, S.& P. said, and they will be chosen to represent the market broadly.

Mr. Schulman says an asset-weighted index like CSFB/Tremont is more representative.

»Our indexes tell you what the overall industry is doing,» he said. »It’s like comparing the S.& P. 500 with the 30 stocks in the Dow Jones industrial average.»

Brian McQuade, principal at the Hedge Fund Center, which operates an educational Web site, www.hedgefundcenter.com, said: »A sample size of 40 is small. It will be pretty slim pickings.»

Some rivals, however, say they welcome the new index. »The fact that S.& P. is looking at hedge funds adds credibility to the asset class,» said Charles Gradante, chairman of the Hennessee Group.

Standard & Poor’s acknowledges that its index has its shortcomings and should be but one tool for investors in evaluating hedge fund investments.

»We’re not trying to pick the best managers, just a representative sample,» Mr. Aaronson said. »We are trying to bring some order to the chaos in the marketplace about hedge funds.»

Photo: Paul Aaronson of Standard & Poor’s is leading a team in developing an index for the often vague world of hedge funds. (Ting-Li Wang/The New York Times) Chart: »Tracking an Expanding Universe» With the market for hedge funds growing rapidly in recent years, Standard & Poor’s plans to start its own hedge fund index this summer. Existing indexes have reported widely varying returns. CURRENT BROAD-BASED HEDGE FUND INDEXES: CSFB/Tremont Hedge Fund index THIS YEAR THROUGH APRIL: 1.5 3-YEAR ANNUALIZED RETURN: 9.9% 5-YEAR ANNUALIZED RETURN: 9.7% CURRENT BROAD-BASED HEDGE FUND INDEXES: Hennessee Hedge Fund index THIS YEAR THROUGH APRIL: 0.9 3-YEAR ANNUALIZED RETURN: 12.9 5-YEAR ANNUALIZED RETURN: 11.2 CURRENT BROAD-BASED HEDGE FUND INDEXES: Van Global Hedge Fund index THIS YEAR THROUGH APRIL: 1.7 3-YEAR ANNUALIZED RETURN: 17.0 5-YEAR ANNUALIZED RETURN: 19.2 Graph shows NET MONEY FLOWS FOR HEDGE FUNDS* since 1994. (*Based on a universe of 2,845 funds) (Sources: Tremont Advisers; the companies)