Interesting take on hedge funds. Vultures circling?

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Hedge funds delivered strong returns in the first quarter of this year and with market volatility expected to rise and clear trends evident in currencies and bonds the omens for 2006 are good . . .

"It's been a good start ... There is a very good chance that we will do better then we did last year," said Ian Morley, chief executive at Dawnay Day Olympia.

Whether hedge fund returns do exceed those of equities this year remains to be seen and few are prepared to forecast the sort of event that could trigger a major stock market correction.

But the fact that wealthy individuals, who are usually ahead of the game and who have been heavily invested in stocks for the last three years, are once again focusing on hedge funds is a clue that equity market sentiment could be turning negative.

Distressed investing--putting money into high-risk debt that most others won't touch--sure ain't what it used to be. Too bad for the hedge funds and institutions that dominate this field. A daunting $17 billion poured into distressed securities last year (double 2000's inflow). Aim: to buy cheap bonds in hopes of scoring big in restructurings.

These hoped-for scores aren't abundant, though: Returns of hedge funds specializing in distressed paper have averaged only 2.2% over the last 12 months. That's a far cry from the 34% returns these funds earned in 1991 as the economy was pulling out of a recession. The difference: Last time there were many good companies with bad balance sheets; this time they're often bad on both counts.

Is anyone winning this game lately? Among vulture investors, one name is mentioned often with both envy and appreciation.

David Matlin has been averaging 40% returns annually since he started in 1994 running Credit Suisse First Boston's vulture fund. Okay, these returns aren't publicly available, but Matlin says his auditor Ernst & Young vouches for them. And few in the distressed-investing community are surprised by them. "I haven't seen actual returns, but that all fits together," says Thomas Cole, managing director at Deutsche Bank, which trades with distressed-debt scavengers.