CAMBRIDGE, Mass (HedgeWorld.com)–In a newly published book, Daniel Quinn Mills, a professor of business administration at Harvard Business School, makes sweeping charges against the hedge fund industry in general and funds of funds in particular, warning that retail investors are in danger of an outcome not likely to be better than that of the Internet investment mania of the 1990s.

The book, “Wheel, Deal, and Steal,” from Pearson Education Inc., Upper Saddle River, N.J., has a very broad scope–it discusses the whole range of ills that afflict the securities industry and ancillary fields today and what Mr. Mills believes ought to be done about those ills.

The material specifically devoted to hedge funds was excerpted Oct. 6 in the HBS publication “Working Knowledge.” It is hardly less scathing than the book’s title might lead one to suspect. Mr. Mills contends that investment banks have made the fund of funds the new big thing in order to entice investors to entrust their money, indirectly, to the same people who lost it for them during the ’90s bubble. Investments, he writes, are “laundered, so to speak, through a big bank that pretends to impose some prudence in management on the hedge funds in which the investors’ money ends up, then until another collapse, funds of funds will be considered suitable investments.”

The underlying funds themselves follow a herd mentality, the excerpt contends, and this contributes to the increased volatility of the stock market.

“When they all go long, the market rises–when they all go short, it falls. They tend to go one way, then the next–and the market experiences violent shifts from day to day, but in a narrow range without much of a trend,” he said.

Because of this directionless volatility, the negative effects of the new big thing for investors will take a somewhat different form than they did the last time around. There won’t be a price run-up and collapse. Rather, investors will find that their assets are consumed piecemeal, “in arcane positions trading with or against the market, sometimes in so complex a fashion that not even the fund managers will know exactly what caused an investment to be a success or a failure. … The investor is further away from the actual management of his or her fund than during the Internet bubble. The outcome is not likely to be much better.”

The professor is particularly unhappy that “the net worth measure is somewhat elastic, and smaller investors are creeping into these funds” through the funds of funds.

Critics of the hedge fund industry have made many of these points before. Industry spokesmen, in reply, have stressed that sophisticated investors, such as funds of funds and other institutions, have the capability to do a great deal of due diligence upon the underlying funds. Furthermore, spokesmen for hedge funds deny that such vehicles increase market volatility, pointing for example to a study by Mr. Bing Liang, a professor at the Weatherhead School of Management, Case Western Reserve University, “Hedge Fund Performance: 1990-1999,” which found that during that period, the Standard & Poor’s 500 stock index was much more volatile than the overall hedge fund markets Previous HedgeWorld Story.

CFaille@HedgeWorld.com