Anyone want to bet where the next big financial blow-up will occur? My money is on hedge funds.

Growth in hedge funds has been phenomenal. Roughly $850 billion is now invested in these high-risk, unregulated investment pools. That's more than double what they held in 2000.

Investors, tired of the big losses in stocks and stock funds, increasingly have turned to hedge funds as the place where rich, savvy investors cash in. Investing in a hedge fund has a cachet that investing in stocks or mutual funds can never offer.

Out of the frying pan ...

The timing of this growth is no accident. A lot of speculative money that came out of technology stocks in the last few years has poured right into hedge funds.

There are roughly 7,000 hedge funds today. That's almost half as many as the number of mutual funds.

Hedge funds are very different from mutual funds, although both have a professional money manager investing a pool of money for many investors.

Mutual funds are registered with the Securities and Exchange Commission and must meet strict disclosure and other regulatory requirements. They typically have low minimums. Hedge funds, on the other hand, are partnerships that aren't currently governed by any regulatory body. They usually have high minimums. And only wealthy investors need apply. To invest, you typically have to be an "accredited investor." That means having a net worth of more than $1 million or an income of more than $200,000. If you use a financial adviser, you can invest with a somewhat lower net worth or income.

Hedge funds generally offer money managers a way to cash in quickly. A couple of years running a successful hedge fund, and you can retire rich. The money manager generally gets a 2% annual management fee, plus 20% of all the gains of the fund.

That kind of arrangement gives the managers incredible incentives to take big risks. And they do.

Most hedge funds borrow heavily to turbo-charge their investments. That grossly magnifies any gains they make, but it also inflates their losses. They make huge bets on the directions of such things as currencies, interest rates and stocks.

The next time a currency, or interest rates or the stock market lurches suddenly in a direction that few people expect, watch out: Some hedge funds are going to get wiped out.

Too many players, not enough oversight

Don't get me wrong: There are some brilliant hedge fund managers. But nowadays, everyone and his brother are running hedge funds. An ordinary investor -- even one with several million dollars -- is going to have a very difficult time identifying the good funds, much less getting into one of them.

There's very little unbiased research on hedge funds. Moreover, brokerages are pitching hedge funds to their well-heeled clients. At the same time, the brokerages are soliciting trading and other business from the same hedge funds. Brokerages have huge incentives to get clients to invest in hedge funds that send them trades, rather than trying to identify truly superior hedge funds for clients.

The Securities and Exchange Commission is moving, at its usual glacial pace, to require that hedge funds register and to regulate them. But there's little political muscle behind that effort.

My advice: You should steer clear of these dangerous vehicles. About all you can hope for, I'm afraid, is that the inevitable blow-ups don't happen with your money.

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