With all the focus on private equity, many finance commentators seem to be paying less attention to the inexorable rise of hedge funds.

According to Hedge Fund Research, the industry saw $60 billion of inflows into funds in the first quarter of 2007. This is nearly half of the record $126 billion in new assets for all of 2006.

What is interesting, however, is the fact that amongst the buffet of investment styles offered by hedge funds, distressed hedge funds accounted for 13% of inflows for the quarter. This class saw net outflows in the fourth quarter in 2006.

Distressed hedge funds are simply a class of funds which invest in the debt of down-and-out companies. Considering the never-ending stream of record highs we are seeing on global equity markets at the moment, one might ask why anyone would put their money into such funds.

That is precisely the point.

In global equity markets at present, Mr Ed could be delivering you a 10% annualised return. The question, however, that the world’s smartest investors are clearly asking themselves is rather than run lemming-like over a cliff, is it time to start reassessing where the opportunities may be in the next one to two years

Given the preponderance of Dad-and-Dave-style hedge funds seemingly attempting to open up in a suburb near you, it is a good time for Australian investors to take a long hard look at anyone who starts promoting the next big thing or is looking for some “seed” money. If the flow of money into distressed debt funds turns into an avalanche, Dad and Dave Fund Management is not where I’d be putting my money.