London is awash with tiny hedge funds. Even after the bloodletting of recent years, there were still 55 hedge funds managing more than $1bn in the city at the last count, and hundreds managing substantially less.

In light of the EU’s ruling that hedge funds managing more than €100m (with leverage) and hedge funds managing €500m (without leverage) have to comply with onerous reporting restrictions, the shape of London’s hedge fund industry is likely to change over the next few years. Big hedge funds may get bigger, medium sized ones may choose to leave the EU, very small ones may thrive.

So how do you know whether the hedge fund you’re joining is a dog or a star? You could consult this list. You could do some due diligence along the lines suggested below.

1) The investors

Who are they? Is the fund based largely around partners’ own money, what percentage comes from outside investors and who are they?

“A diversified basket of investors is clearly better,” says John Godden, chief executive of hedge fund consultancy IGS Group. “In the past, there have been issues around funds being over reliant on a single investor, whether it’s institutional or private.”

“Theoretically, the more diverse the investors, the better,” agrees David Durham of hedge fund search firm Durham Consultants. “However, plenty of people are simply happy to have a desk, an allocation of capital, and to make sure that their boss is a decent guy.”

2) The direction of inflows

Are assets under management increasing, or are investors withdrawing their money? The former is, evidently, preferable.

“Most hedge funds will have suffered a drop in assets under management in 2008,” says Godden. “You want some sort of evidence that they are now growing again and that there have been net inflows in the last 18 months.”

3) Lock-ins

Most funds have followed the likes of Citadel and prevent their investors from removing money for at least two years.

The danger is that once these two years are up, investors will remove all their money all at once. “Is there a large core of disenchanted investors who are going to take their money out at the earliest possible opportunity?” says Nicola Ralston at investment consulting company PiRho.

4) High water marks

Most hedge funds operate a system of high watermarks under which a fund has to reach its previous highest value in order to charge performance fees. If the fund fails to meet this mark it will be unable to charge performance fees and will be subsisting entirely off the management fee. Needless to say, funds reliant on management fees are unlikely to pay particularly well.

“As of May 2010, you would expect most funds to be either at or just below their high water mark,” says Godden.

5) Performance

The all-important measure is a fund’s performance relative to its peer group. EurekaHedge and HedgeFundResearch offer performance information, but you’ll have to pay.

6) The reputation of the partners

There are some crazy-sounding people running hedge funds. Take the portfolio manager who allegedly forced a trader to take female hormones and worse.

“If you are going into a smallish hedge fund that’s very dominated by a founder, it’s worth trying to find out what the culture’s like,” says Ralston. “A lot of people are very talented and charismatic, but some people are very domineering and controlling. Do your best to understand what you’re getting into.”