Amid the debate whether hedge funds are saintly or sinister, the facts around what they are, what they do and how they do it are pretty mundane.

They have a legal structure for fees that will enrich managers – more than other investment vehicles – but only if they exceed a performance goal, such as beating the market. Activists and investors are always trying to push those fees downward. It’s hard to find really good hedge fund managers who can beat the market consistently. And hedge funds lose a lot of money when financial markets take a beating in ways their managers don’t anticipate.

In other words, about 50 years after the first hedge fund emerged, they are starting to look a lot like other investments.

But hedge funds aren’t something you might invest in from home online. With about $3 trillion in assets, hedge funds are also no longer solely the playground of rich people who’ve pooled their money either. Nor have hedge fund managers concocted a secret sauce that lets them make money no matter what.

An orthodox view holds that markets are so efficient at pricing assets — stocks, bonds or anything else — that beating them by earning a large return isn’t much more than dumb luck. “Plenty of hedge funds have no real ‘edge’ — if you strip away the marketing hype and occasional flashes of dumb luck, there is no distinctive investment insight that allows them to beat the market consistently,” Sebastian Mallaby wrote in his 2010 history of hedge funds, “More Money Than God.”

So why has the industry grown? The roughly $3 trillion invested in hedge funds is an eye-popping number, to be sure, but a little context demystifies it somewhat.

By the end of 2014, for example, Americans had invested $15.9 trillion in mutual funds, the often humdrum investment vehicle behind retirement savings, according to the Investment Company Institute. The New York Stock Exchange had a capitalization of $18.4 trillion at the end of 2015. Investors globally own $13.6 trillion in U.S. Treasury securities. And the $3 trillion hedge funds own is divided up among about 10,000 different funds. In short, hedge funds have a lot of money, but they are by no means some kind of overweening, monolithic force in the world’s financial markets.


“Humility and Scepticism”

Nor do hedge funds have a license to print money, as the year 2015 proved for most funds.

Hedge Fund Research Inc., a Chicago-based consultancy, keeps an index that aggregates all types of hedge funds’ performance, and it showed a return of negative 1 percent last year, only the fourth year of losses since it created the gauge in 1990.

But many funds do show consistently strong returns. The Bridgewater Pure Alpha hedge fund, run by manager Ray Dalio, has earned $45 billion since it was set up in 1975, and now manages $82.3 billion in assets. George Soros, who became a legend by betting that the Bank of England wouldn’t be able to avoid a devaluation of the British pound, has pulled in $42.8 billion with his Quantum fund since 1973. It now handles $29 billion in assets.

Even high-flyers can have bad years. Bill Ackman, who ranked as one of the top 20 hedge funds for 2014, fell off the list last year when the fund was down 20.5 percent — slightly more than a fifth. Ackman bluntly acknowledged the failure to his own investors.

“While no one here is enthusiastic about delivering our worst performance year in history in 2015, it certainly does a good job reinforcing the humility-side of the equation that is necessary for long-term investment performance,” Ackman wrote in an annual letter to investors. “In 2016, we would like to generate results that reinforce the confidence side of the equation. Humility and scepticism will help get us there.”


Where to Find Alpha

And with literally thousands of other hedge funds in the market, last year there were many other Ackmans—strategists whose plans went badly awry. The funds that are the most successful tend to have long track records that have helped them build up the assets they manage, as investors are attracted to the apparent expertise they have.

The 20 most profitable hedge funds earned $15 billion last year, while the rest of the industry lost $99 billion, according to LCH Investments, which studies and invests in the sector. Those top performers have made 48 percent of the $835 billion in profits that the hedge fund industry has generated since its inception.

“There are funds that are large without those track records,” said Kenneth Heinz, president of Hedge Fund Research. “But most funds that have long track records are large.”

So what do the ones who rack up such big profits actually do? How are they different from the ones that lose money?

Any investor can make big bets, like buying a broad range of stocks and using borrowed money to make the bet many times over, but winning hedge fund managers don’t do that. They look for good risk-adjusted returns, opportunities to make profits out of proportion to the risks they take. In other words, the best ones make a high return without taking on the high risk that defines truly reckless gambling. In the jargon of the industry, those managers have “alpha.”


The “Hedged Fund”

Alfred Winslow Jones, generally considered the godfather of the industry, called his creation in the 1960s a “hedged fund,” because he sought to minimize the risks of buying stocks. He hedged his bets. Winslow might buy some shares he thought would rise, and others he expected to fall. If the whole market moved in one direction or the other, it would be a wash.

But if he correctly picked his shares, he’d make money, both from the ones going up, and the ones that fell. And Winslow promised his investors he’d only make money if they made money, by taking a fifth of the earnings.

Heinz pointed out that the tough year the industry faced last year bears out what Winslow figured out in the 1960s: you make the most money when some shares — or bonds, or currencies or anything else one might bet on — go up, and others go down. Last year was a tough one for bonds, and stocks, he noted.

“The best periods of performance happen when you get different assets going in a different direct,” Heinz said. “That was not true in recent months.”

Since Winslow created the hedge, the types of funds have only multiplied. Broadly speaking, they fall into four categories that Hedge Fund Research uses to make sense of a very broad category: funds invested in stocks of companies; funds that bet on certain events, like a merger; funds that try to arbitrage the minute price differences between similar assets; and funds that bet on the overall macroeconomic conditions of countries or regions.

There are also funds that trade on the reputation of hedge funds without having much resemblance to Winslow’s original idea.

The result of the proliferation of strategies has been that hedge funds now have mainly one thing in common: the fee structure that gives hedge fund managers a piece of the holdings and the profits. By the 1990s, it was “2 and 20” — 2 percent of the assets under management, and 20 percent of any gains beyond a certain threshold, like beating the market.

That’s a hefty enough pound of flesh for investors, be they individuals or pension funds.

“We have seen pressure to reduce what management fees actually are each quarter,” Heinz said. “Fees have trended lower, and they are almost always lower than 2 and 20. There are a lot of funds that charge that, but lots who charge much lower fees.”

The ultimate threat of an investor who doesn’t like high fees is to go somewhere else. But where?

If the lion’s share of profits are made by large, well-established hedge funds, then investors don’t have as many places to go as the number of hedge funds that currently exist — about 10,000 — suggests. In other words, investors in hedge funds face the same dilemma that investors have faced for time immemorial, namely to find smart investments — the elusive “alpha” in the hedge fund world — that haven’t already been discovered by everyone else, and justify the lucrative fees.

Barry Ritholtz, a prominent commentator on financial markets, has put it succinctly: “No one seems to have cracked the simple puzzle: How can we identify in advance those unheralded managers who are likely to generate alpha in the future?”


Is It Possible to Spot Winners?

Some major pension funds have concluded that they cannot pick the winners.

Calpers, the California public employees pension fund with about $276 billion under management, bailed out of hedge funds in 2014, and sold the $4 billion it had invested with them. Since then, data on how other big institutional investors have adjusted their holdings has been mixed, and Heinz warned against seeing Calpers as a bellwether.

“The sea of capital that is making decisions about hedge funds is large and involves lots of institutions who don’t publicize what they do, so the opinion gets skewed by a few that do,” Heinz said.

What is unquestionably true is that hedge funds have come under greater scrutiny about the value they do offer investors, a logical enough development for an industry that was largely unknown to the public for the first half of its history.

The Roosevelt Institute, a left-leaning, New York-based think tank, and the American Federation of Teachers, which is active in anti-hedge fund protests, used publicly available data on 11 public pension funds to determine whether their investments in hedge funds had paid off. The study found hedge funds couldn’t outperform the rest of the pension funds’ investments in stocks, bonds and other financial instruments while pensioners also lost money to high hedge fund fees.

“Is there any merit for going after the funds that do beat the market?” asked Saqib Bhatti, a co-author of the study. “No. There’s very little evidence to suggest that anyone can consistently beat the market.”

But the best hedge funds do have a remarkable string of good luck, and often do very well when others falter.

“Over the past 10 years, which includes the period of the global financial crisis, the top 20 managers collectively made $304.8 billion,” Rick Sopher, chairman of LCH Investments, wrote in his company’s report on the industry. “This is a staggeringly good return, showing that it is possible to make significant profits for investors, even in the most challenging of conditions.”