Sept. 5 (Bloomberg) -- Moody's Investors Service, Standard & Poor's and Fitch Ratings are developing criteria to evaluate the soundness of hedge funds in response to appeals for transparency from investors and regulators as inflows surge.

Systems are being developed to appraise how well hedge funds are run and will be ready to use by the end of the year, according to separate statements from the ratings companies. Sorin Capital Management L.L.C., a New York-based hedge fund manager with $335 million under management, was today rated OQ1- -- within the highest ranking group -- in the first hedge fund rating by Moody's.

``These ratings are on the manager as opposed to the fund itself,'' Kathryn Kerle, vice president at Moody's, said today by telephone. Moody's won't rate the creditworthiness of hedge funds or the effectiveness of an investment strategy, she added.

Hedge funds had assets of $1.2 trillion at the end of June, after attracting $42.1 billion during the second quarter, the highest quarterly inflows since at least 2003, according to Chicago-based Hedge Fund Research Inc. Many institutional investors, including several public pension funds, are increasing their allocations for so-called alternative investments.

Hedge funds are loosely regulated investment pools designed for wealthy investors and institutions. They seek to make money in both rising and falling markets and often take more risk than conventional funds.

The new ratings will focus on the risk of loss resulting from a hedge fund's inadequate control of its own operations and systems, the companies said. The so-called operational risk has attracted the scrutiny of regulators including the Basel Committee on Banking Supervision and the U.K.'s Financial Services Authority.

``Successful hedge fund managers have a tendency to grow extremely rapidly,'' the FSA said in a June 2005 report. ``Growth beyond their control capacity is an extremely real risk.''

`Ability to Deliver'

``We want to rate a manager's ability to deliver on his or her promise,'' said Charles Prescott, managing director at Fitch Ratings, a unit of Paris-based Fimalac SA, in a telephone interview on Aug. 24.

Moody's, a unit of New York-based Moody's Corp., will derive its ratings from assessments of a hedge fund's valuation process, accounting controls and regulatory compliance effort, according to a report on its Web site. It will also consider risk reporting and control, legal and financial structure, human resources and other ``fund specific issues,'' Moody's said.

Sorin Capital, founded by former Bear Stearns Cos. executive James J. Higgins in 2004, received the top rating for the quality of its operations. ``SCM has built and maintains an infrastructure with excellent operations quality with only a few areas for improvement,'' Moody's said.

S&P, a unit of New York-based McGraw-Hill Inc., ``plans to publish revised criteria for the rating of hedge funds by the end of the year,'' Tanya Azarchs, managing director of financial services ratings, said in an e-mailed statement on Aug. 25.

The Wall Street Journal reported earlier today that Moody's would release its first public rating of a hedge fund.

To contact the reporter on this story: Andrei Postelnicu in London at apostelnicu@bloomberg.net.

Last Updated: September 5, 2006 07:10 EDT