Hedge funds have had a good run as of late, and by a several measures they've managed to beat the major stock market indexes so far this year. Over the first nine months of the year, the Barclays hedge fund index has soared 5.2 percent. That compares with a 3.91 percent gain for the S&P 500 and a 4.1 percent return of the MSCI index. Other indexes put stocks about equal with hedge funds.

But the dirty little secret may be that the hedge funds have been riding stock market beta for much of its gains. It's no secret that correlation has emerged as an issue in the trying economic times and have led to mass movements and a herding.

The median 90-day correlation of 0.72 among the S&P 500 stocks as of Sept. 30 is very close to its historic high over a 10-year period of 0.79, which was reached as recently as July, notes Investment News. By one measure, correlation has hit 0.80.

Hedge funds will have a hard time operating in such an environment; the alpha will be trickier to come by. So it may be best to brave the storm by riding the S&P 500 beta and then seeking differentiation once the macro-environment becomes less volatile. Some think the correlation bubble is about to pop.

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