The Goldman Sachs (NYSE: GS) Global Alpha fund is supposed to be as close to perfect as any pool of money in the world, yet was down 22.7% in August [subscription required] according to the Wall Street Journal. The fund has a multi-strategy approach that allows it "the flexibility to adapt to volatile and difficult markets and avoid problems arising from any single strategy." Global Alpha has given very good returns but the music stopped about a year ago. Over the last 12 months, the fund has lost 37% of its value.

The drops shows that even very smart people can make dumb moves and stick with them too long. The Global Alpha manager has made bad decisions about investing in the Norwegian stock market, the Australian dollar, the Japanese yen and Canada's currency.

The Journal says that the problems at the fund are an example of what happens when many large institutional investors put money into similar ideas. When the market moves against these, too much money tries to exit those investments and their value drops sharply.

Well, that may be true, but the partners at Goldman are supposed to be the best in class. In other words, they are supposed to stay away from those investments that everyone else is making and find even better markets. That is why they are paid tens of millions of dollars a year.

The fund's managers must have forgotten what got them their positions in the first place. They were smarter than everyone else. At least for a while.

The Wall Street Journal is reporting [subscription required] that poorly-performing 'quant fund' managers will be forced to explain their recent poor performance to investors in their funds beginning this week. Despite normally remaining quite secretive and under-the-radar, many of these fund managers are being forced to hold conference calls in order to save the reputation of the firms they work for.

All of the negative news from investment bank-owned hedge funds such as that from Bear Stearns (NYSE: BSC), Barclays (NYSE: BCS) , and Goldman Sachs (NYSE: GS) points to significant risks in the asset management business. When times are good, profits and positive news from the hedge fund businesses inside these investment banks is plentiful. But when times begin turning bad, as they seem to be now, the risk of destroying a firm's reputation is quietly intertwined with any signs of poor performance.

Investors need to now be extra careful before investing in the financials. Derivatives exposure, topping private equity activity, hedge fund risks, and subprime vulnerability are all uncertainties and potential sources of destruction that need to be remembered before purchasing these stocks.

Barron's [subscription required] revealed some scary statistics about this week's carnage. The smartest of the smart are finding that their computer models are telling them to do the wrong things at the moment of maximum peril. As a result, The Goldman Sachs Group's (NYSE: GS) $8 billion Global Alpha hedge fund is down 26% so far this year and the $26 billion Renaissance Institutional Equities Fund -- run by the $1.7 billion (2006 compensation) man, James Simons -- has fallen 8.7% so far this month.

What is going on? The computer models that run these funds don't model what is happening now -- a simultaneous dash to liquidate by all their peers. Statistical factor-based quantitative models -- which weight dozens of valuation, growth, and momentum variables to create long/short portfolios -- have attracted many competitors.

Their models broke in recent weeks as volatility surged, leverage was cut back, heavily shorted stocks went up and statistically cheaper shares cracked. One anonymous manager said "There is this unknown risk, when there are enough people doing what you do, that when some of them have to unwind and they start unwinding -- you are just going to get crushed. And that's not in the model anywhere."

Forbes raises a question about whether The Goldman Sachs Group (NYSE: GS)'s $9 billion hedge fund, Global Alpha, will fail. I don't know, but rumors to that effect raise serious questions about whether the banks will be able to clean up the messes they make in pursuit of those eight figure bonuses. That's because Global Alpha is a symptom of a bigger problem -- the Black Box Market.

I pointed out that Global Alpha was having problems a few months ago in this post. So it doesn't surprise me to read that it's down 16% for the year. Global Alpha lets computers make decisions. Its investors just have to trust that those computers always make money no matter what happens. Unfortunately, the 1998 collapse of Long Term Capital Management demonstrates that smart computer programs can fail at the point of maximum peril.

And this brings us to the Black Box Market. As this morning's announcement by BNP Paribas that three of its subprime hedge funds will not redeem investors' money suggests, the global capital markets are at risk because of their opacity. Specifically, The Black Box Market entails four mysteries:

Goldman Sachs Group Inc. (NYSE:GS) is a firm that can do no wrong? No doubt, the company has had a tremendous year (just look at the surge in the stock price).

But, there are some imperfections. Take the company's mega hedge fund, Global Alpha, which has about $10 billion under management. The fund's performance for the year is down about 11% (it looks like August was a particularly bad month).

Basically, the fund uses whiz-bang computer models to help make investment decisions. Unfortunately, the algorithms made some bad bets on Japanese bonds, as well as US Treasury bonds.

Then again, Goldman Sachs has a long view on things (this is the luxury of being ultra wealthy). After all, last year, the fund posted a standout 40% return.

Tom Taulli is the author of various books, including the Complete M&A Handbook and operates DealProfiles.com.