THE most authoritative academic study into the burgeoning hedge fund industry has advised individual investors to shun them or minimise their exposure.

A group of American economists studied the industry, which they say consists of more than 8,000 funds now holding $1 trillion (£583 billion) in investments. They found high fees, inconsistent data and hard-to-understand risks.

The industry badly needs standard measures of performance and risk to allow investors to compare funds’ actual track records and the degree of risk that they are taking on, they said.

The concerns are raised in a report by the Financial Economists Roundtable, a group of American finance researchers, who meet annually to discuss micro-economic policy issues in the United States and elsewhere. The study, published on the website of the Stanford Graduate School of Business, reflects a consensus among the majority of contributors who attended this year’s meeting.

They recommend that banking regulators discourage speculators from taking risks with hedge funds by making it clear that government cash will not be used to rescue troubled funds. They found that, while hedge funds typically have wealthy individuals as partners and investors, less wealthy individuals were increasingly taking stakes. They advise pension fund managers to make only “modest” investments on behalf of individuals.

James Van Horne, the AP Giannini Professor of Banking and Finance at Stanford, said that even sophisticated investors might not understand all the expenses and risks. He pointed to the so-called “high-water mark” — the fee that the funds take for performance gains over a certain threshold, typically 20 per cent of those gains.

“One consequence often overlooked by the investor is the fact that when cumulative returns fall below the mark for generating fees, the general partner can close the fund in order to establish a new base for setting fees,” Mr Van Horne said.

This structure creates an incentive for the hedge fund to adopt a high-risk strategy, as those managing it stand to gain greatly if this strategy succeeds but will not suffer losses if it fails, the report argues.

Christopher Fawcett, chairman of Britain’s Alternative Investment Management Association, said: “Every point made here has been made by somebody in the past.

“It’s impossible to generalise about hedge funds. They are very different in what they do, in the risks they represent and in the returns they seek to make.”

He said that the suggestion that individuals should limit their involvement in hedge funds raised questions over the rest of their portfolio. The economists say in the study that standard measures of volatility and performance do not apply because of the unique nature of hedge funds, and this makes comparisons with competing forms of investment difficult.

OVER-EXPOSED

KL Financial: this Florida-based hedge fund was forced to close in February after the FBI and the Securities & Exchange Commission found that investors lost $250 million

Wood River Partners: the founder John Whittier faces civil fraud charges, accused of making “material misrepresentations” to investors in two funds with $265 million under management

Philadelphia Alternative Asset Management: collapsed this year, with its founder, Paul Eustace, accused of defrauding investors by lying about investment returns. At one time it had $230 million under management

Portus Alternative Asset Management: 26,000 investors put around C$800 million (£392 million) into this hedge fund, which now is being investigated by Canadian regulators

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