With a strong bull market and bank stocks at nosebleed altitudes, the sector is increasingly in the sights of hedge funds.

The number of bank hedge funds, which can trade more nimbly and aggressively than their mutual fund counterparts, has more than doubled, to 69, in the last two years, and most consultants say more are on the way.

As a result, bank stocks-particularly those of smaller banks-could be subject to more volatility. Indeed, some see the arrival of hedge funds as a signal that the market is about to turn.

"It is a frightening phenomenon," said one hedge fund manager who declined to be identified. "It indicates that it is a time of the excess of a bull market."

Globally the number of bank and financial hedge funds has risen from just five before 1990. Much of the increase came in 1995 and 1996, when the number doubled, to 60, reports Van Hedge Fund Advisors Inc., Nashville, a leading consultant in the hedge fund field.

Market experts say affluent investors are fed up with oversized and sluggish mutual funds and are turning to more flexible investment vehicles to produce returns, said hedge fund consultant Lawrence Bondurant. She said hedge fund managers have an array of investing strategies at their fingertips-including short-selling and trading in options and futures-that mutual funds cannot employ.

"Hedge funds have provided a catalyst for investors to move out to smaller shops so that they can get a bigger piece of the action or a larger equity stake," said bank analyst Michael L. Mayo of Credit Suisse First Boston.

One co-manager of a hedge fund, Michael Salzhauer of First Matthews Partners, New York, describes himself as a value investor-one who buys low and holds stocks. "I think some people have come to invest with us because our fund is viewed as less risky," said Mr. Salzhauer. "I think the fact that the performance of our stocks is less linked to the market overall has appealed to investors."

Nevertheless, Mr. Salzhauer pointed out that market swings have encouraged more trading in and out of bank stocks than before.

A rise in bank hedges could also speed along the already rapid consolidation that is sweeping the industry.

"A lot of hedge funds have been playing the takeover game," said Ms. Bondurant, a managing director of HFR Analytics, a division of Hedge Fund Research Inc.

The result is that smaller banks and thrifts could find themselves faced with investors who are much more vocal in advocating deals.

"Many investors have been buying positions believing that the company will be acquired," said Mr. Salzhauer. "Since consolidation has been going for a long time, there will be more pressure from investors to make that happen."

Seymour Holtzman, who runs the Holtzman Value Fund and has pressured several thrifts to sell, agrees.

"Underperforming managers of financial institutions have to be aware that investors, particularly hedge funds managers, are proactive in terms of making sure that banks perform well and they are focused on shareholder value."

The bigger players in the niche market include Keefe Managers in New York, Boston Providence Partners in Fort Lee, N.J.; Bay Pond Partners LP in Boston; and Ashton Enterprises, a large bank hedge fund managed by Friedman Billings Ramsey & Co. in Arlington, Va.

These funds have many millions of dollars apiece under management. Hedge fund consultant George Van notes, however, that newer players are likely to have only a small portfolio under management and that they are likely to trade in small banks and thrifts.

Some of the newest players include the Acadia Fund in New York; Mendon Capital, Kalamazoo, Mich.; Kamco Thrift Partners, Chicago; Financial Edge Fund, Chatham, N.J.; and Castle Creek Capital Partners, San Diego.

Bank hedge funds have been the most profitable of the sector funds this year, averaging a 29.9% annual rate or return, Mr. Van said. Another fast- growing sector, emerging markets, averaged 22.2%, he said.

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