Six red flagsLightly regulated hedge funds are the fastest-growing segment of the Canadian financial market. With experts saying more flameouts are bound to happen in the sector, here are a few warning signs that investors should consider.

1. Higher-than-average returns

If you believe you're investing in a low-risk hedge fund, look at your returns. A double-digit return in a single month may indicate you're not in a low-risk fund, according to Tim Mungovan, a partner at Nixon Peabody LLP in Boston and head of the firm's investment partnership litigation practice.

2. Prevalence of credit derivatives

In the U.S., there's a mounting concern among experts about the sudden prevalence of credit derivatives, or contracts that are designed to allow hedging of credit risk.

3. 'Style drift'

Unlike other investments, hedge fund trading positions can fluctuate wildly from month to month. That's why it's vital to keep close track of any changes in the fund.

4. Overegging one basket

Beware of funds that aren't well diversified, both in terms of where they invest and who does the investing.

5. Legal structure

Pay attention to the legal structure of your fund. Many, at least in the U.S., are limited partnerships, which may make it more difficult for investors to take legal action in the event of any losses.

6. Complexity

Hedge fund strategies are becoming ever more complicated, and risk management systems may be failing to keep up. As numerous case studies of hedge fund blowups have shown, investing in complex trades is risky business.