This year the S&P 500 is up 8 percent, while hedge funds are up 7.2 percent (on the HFRI index). Not scintillating. The problem: too many hedge funds are doing the same thing, and market volatility has been low. Volatility is what drives performance because hedge funds can leap in and out of the game, profiting from wild swings in markets. With volatility low, ambitious (or should I say greedy?) funds are trying to perform by leveraging up positions or going into exotic asset classes. There are about 300 hundred-billion-dollar hedge funds, and most trades are so crowded that no matter how athletic you are, it’s hard to avoid getting trampled by some rookie on his first bad play.

One of the big blowups, Amaranth, had a major part of its assets leveraged up in natural gas, run by a young trader who had been on fire but went cold. Natural gas fell when it was supposed to soar, and Amaranth lost something like $6.5 billion, or more than half its capital, in a couple of weeks. Recently other hedge funds have had similar, if less dramatic, experiences with wrong-footed speculations in currencies and bonds. When a fund takes a big hit, its clients flee en masse.

The hedge-fund model is both magnificent and profoundly flawed. You can start up with a couple of million dollars, and if you have a good line of palaver and shoot the lights out in your early years, you can raise billions. All of a sudden, with a fee of 2 percent on $10 billion, you are collecting $200 million a year just for turning the lights on. Suppose you appreciate 20 percent. That’s $2 billion, of which the managers get 20 percent, or $400 million. You hire analysts, client-service officers, public-relations experts, your out-of-work college buddy. Suddenly you have hundreds of staff. Amaranth had 420.

Next you buy houses in Nantucket, Aspen and the south of France, join fancy golf courses, trade in your wife for a younger and more nubile one and purchase a G-5. To have time to enjoy your new toys, you turn over day-to-day management to some brilliant young guy who reminds you of yourself 10 years ago. Now, out of the investment blue that has no memory or respect, you take a hit the way Amaranth did. Overnight, all your investors and assets flee. Suddenly, the 400 employees you now have are just plain overhead. A hedge fund with $10 billion can go to less than a billion in a year and be out of business a year later.

Is that bad? No, it’s survival of the fittest. The stuffy old firms that do “long only” investing tolerate portfolio-manager mediocrity for years on end. Seventy percent of the long-only funds don’t even equal the index they are supposed to beat. The big investment managers are top-heavy bureaucracies whose objective is to, by hook or crook, collect assets rather than deliver investment performance. But if you are a fiduciary, they are not going to embarrass you with a blowup the way Amaranth did.

The hedge-fund business will continue to attract the best, most obsessed talent because it’s where the money is. Hedge funds will continue to attract investors because they deliver in both bull and bear markets. Being able to sell short is a crucial advantage. But if you are going to invest in them, do it through a fund of hedge funds or pick a few that have proven records and follow them closely.

Here is what to look for. Visit the fund’s offices. Read the mood. Is there a lot of machismo and big talk? Do its risk-control procedures make sense? One Amaranth investor pulled out just in time because it didn’t seem smart that a 32-year-old trader in Canada was controlling half the fund in a highly volatile commodity. Has the fund changed its investment style? If it has, be alert. Amaranth apparently went from being a multistrategy fund going for 8 to 10 percent returns to what in effect was a commodity-trading fund shooting for 18 to 20 percent.

Watch the sociological signs. One fund of funds requires partners of each hedge fund it invests in to answer these questions: How many homes do you own, and where? How many golf courses do you belong to? How many days a year do you ski? Have there been any changes in your personal life? Do you own a private plane? What is the square footage of your principal residence? How many boards do you sit on?

If you sense your hedge fund is changing its spots, get out quickly.