The main Bloomberg hedge fund index, which tracks 2,697 funds, fell 2.2 percent a year in the five years ended June 30. The Vanguard Balanced Index Fund, which has a 60/40 split of equities and bonds, gained 3.5 percent annually, and the S & P 500 gained 0.2% a year.
Many hedge funds can invest anywhere. They can invest in gold, Finnish mortgage-backed securities, or even raw timber. I believe most were formed by those with institutional investment backgrounds and impressive academic degrees who had achieved a track record capable of attracting assets. For example, the largest hedge fund ever was Long Term Capital Management which had come from the risk arbitrage group at Salomon Brothers. In addition to two Nobel prize winning economists who had developed the theory of risk, it was peopled by genius level quants and even a former central banker of Italy.
Its end game wasn't pretty. Its value-at-risk model failed in the face of the liquidity freeze of 1998 as Russia defaulted. The Federal Reserve had to engineer a bailout by bringing together the biggest investment bankers in the country and asking them to put up millions. As an aside, Bear Stearns (may it RIP) was the only participant at the table who refused to put up money (classic "freeloader" case). Some say it is why the investment banking community turned its back when Bear reached the gallow steps in early 2008.