From the Dutch tulip boom in the 1700s to telecom/media/technology stocks in the 1990s, investors around the world have pursued many mirages and paid a heavy price in the process. Now, the investment buzzword is hedge funds. But are these funds the sort of unregulated investments that Irish investors should put their money in?

The hedge fund industry - born in the early 1990s - suffered a major debacle in 1998 when John Meriwether's LTCM hedge funds collapsed ignominiously at the height of the Russian loan default market crisis.

Mr Meriwether was the front man for LTCM and surrounded himself with egg-headed PhD rocket scientists. They enjoyed early success and $1 invested in LTCM in May 1994 was worth $4 in March 1998.

The problem for Mr Meriwether and his colleagues was that, while the fund's models were able to cope and profit from "normal" market movements, the models proved incapable of dealing with once-off calamitous events, such as the Asian market collapse.

But, despite the LTCM collapse, the hedge fund industry has enjoyed phenomenal success. The most recent research suggests that the amount of money in hedge funds has grown at a tenfold rate in the past 10 years and there is currently some $1 trillion (€0.8 trillion) invested in various types of hedge funds.

But hedge funds are going through a rocky period and 2004 has been the worst year for these investments since 1998, with almost half of all hedge funds showing losses for the year. So far this year, the average hedge fund is up just 2.75 per cent.

And some of the big names in the industry are suffering. This month, the London-listed Man Group - one of the major global players with $39 billion under management - announced a sharp slowdown in asset growth and was hit by poor returns from its flagship fund. Man is showing all the signs of a company whose growth is beginning to slow. Is this symptomatic of the hedge fund industry in general?

Hedge funds are unregulated private pools of assets which are invested in a myriad of quoted and unquoted securities. They are often characterised by specialist investment management, heavy concentration in specific areas and often use leverage and derivatives. Their appetite for risk varies.

Hedge funds have moved on since the LTCM collapse in 1998 and not all of the funds operate with the obsessive secrecy that characterised Mr Meriwether and his colleagues. However, risks remain and anybody thinking of investing in hedge funds should be fully aware of the risks.

The potential rewards might be high, but are you willing to accept the level of risk - not to mention the charges - that go with those potential rewards?

The level of regulation of hedge funds is low to non-existent. Even if regulation were to take place, it is difficult to see it having an impact given the complexity and sophistication of these funds and the shortage of hedge fund expertise amongst regulators around the world.

Other risks include the lack of transparency in the investment strategy. Hedge fund managers can change their strategies if their "A" game is not working.

Costs are also an issue - typically hedge fund managers charge a 2 per cent management fee but also take a performance fee of 20 per cent. In effect, the hedge fund managers gobble up 20 per cent of the fund's gains!

In the short-term there are also question marks over the ability of the hedge fund industry to adequately manage the huge inflow of funds. The fact is that the inflow of funds has not been matched by the inflow of investment talent.

No doubt there are those who believe that allocating some of their capital to hedge funds is a legitimate diversification of their investments. However, before you even think of investing in a hedge fund make sure you ask the company selling the fund the following:

Describe the investment team and how they are incentivised.

Describe the riskiness of the fund, its volatility, its exposure to extreme events and its correlation with other investments.

Describe the decision-making of the fund.

Describe the typical portfolio.

What is the capital structure of the hedge fund company?

Describe your fee structure.

What are your top 20 long and short positions?

What is your maximum leverage?

Who are your auditors and custodians?

These are only a few starter questions and perhaps it's worthwhile following the advice of the legendary Peter Lynch, who ran the giant Magellan fund for Fidelity in the 1980s with great success. Mr Lynch summed up his investment philosophy in one pithy phrase: "Never invest in any idea you can't illustrate with a crayon and a piece of paper."

Patrick Lawless is managing director of Appian Wealth Management