The term hedge fund has been widely misused as a catch-all for all types of investment management that fall outside the traditional ambit. The highly leveraged activities of many global macro funds and the proprietary desks of investment banks should not be confused with those that are principally concerned with the elimination of risk, hence the term hedge.

The key is to distinguish between the high-octane leveraged funds and the risk-averse hedged funds that make up by far the largest proportion of this asset class. Indeed, global macro funds, which take big leveraged bets on the movement of currencies and interest rates, make up less than 5% of the total hedge fund universe.

While there are other risky strategies that fall into the hedge fund definition, the majority of new entrants to the arena are typically long/short equity investors. The important point here is that, to invest successfully, only taking on the risk one is comfortable with, nothing can replace serious objective research.

Of course, there is often caution entering what is seen to be the hallowed domain of academics and demons, but only amongst the uninitiated. It is questionable whether the recent LTCM scandal will have thrown back the case for hedge funds in institutional as well as private investors' portfolios. In fact the debacle has put the hedge fund world in the spotlight with the result that many people know that there are many types of strategies under this sobriquet, some of which are far from high-risk.

Nonetheless, many people still have a psychological difficulty with selling something that they don't own. But one should think of hedge funds in different terms. In its most basic form, a hedge fund manager is a long/short investor seeking to buy companies that create wealth and sell those that destroy it, either intrinsically or in terms of the anticipated movement of the share on the stock market. Those that pay greater heed to the former are dubbed value investors; those that focus on the latter are the momentum players.

There is little evidence of any caution in Europe from the revelations that some of the largest banks and even the Bank of Italy had been investing heavily in some of the more risky funds, however. Whether the crisis will deter the arrival of more European-based hedge managers is yet to be seen. Colin McLean's Edinburgh-based Scottish Value Management will be launching a new European hedge fund before the year-end but it has been managing long/short accounts for other groups for over five years.

Prior to the crisis, new hedge fund managers had been arriving on the European equity scene by the boatload. The combination of a long-term bull case for Europe and a wider acceptance of hedge funds lured some of the most talented managers out of the bigger traditional institutions. As European markets roared ahead in the early part of the year, these managers got off to a flying start. And most have responded favourably to the market downturn, stemming the losses otherwise endured by their long-only counterparts.

Suffice to say that almost without exception the long/short equity portfolios have fallen less than the market. In most instances these funds are still registering positive gains for the year to end-September, against a fall for the FT Euro Index (DM) of 1.67%. The star performers have been hotly sought after. Olympus Capital returned 27.5% to end-September, Odey European Fund is up 25.69% and Sierra Global, the New York-based euro hedge managers attained a rise of 28.55%. But the most exceptional performance this year has come from Bayard Fund which rose 76.47% in the first nine months, according to Reuters Funds.

Finally, one of the most important developments of the LTCM crisis has been the increasing unwillingness of fund of fund investors to invest with a fund that has all of its counterparty risk with one institution. The reining in of credit limits and the increasing margin calls from prime brokers placed some managers in an acutely tight liquidity squeeze, in some cases precipitating their downfall. With the same firm often acting as prime broker, banker, stockbroker and distribution agent, as well as administrator of the fund, whilst also trading a proprietary portfolio, the conflicts of interest are manifold. What is more, with all this at stake the chance that one is likely to get objective advice from the salesman promoting the investment is remote.

The purging of the industry of some of the more unwieldy and overleveraged participants is nonetheless good news. But, despite the short-term credit crunch, principally the result of the huge losses in emerging markets, the greedy will undoubtedly be back looking for unsustainably high returns as soon as confidence picks up again.

Simon Hopkins is publisher of Global Fund Analysis, a London-based offshore fund evaluation service that focuses on qualitative evaluations of the top performing international funds

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