Moody's Investors Service has tweaked the way it gauges the operating risks of hedge funds as the ratings service grasps for a beachhead in the secretive sector.

The changes come after the global financial crisis upended many hedge fund strategies, causing widespread losses and moves to lock up investors' money. The pain was compounded after Bernard Madoff's multi-billion dollar fraud came to light, burning thousands who placed money with him through feeder funds.

While some of the largest hedge fund managers pay Moody's to rate their "operational quality," the funds that are rated managed a total of $80 billion at the end of April - a fraction of the $1.3 trillion hedge fund industry.

The limited footprint of Moody's and its ratings counterparts in the hedge fund sector reflects the challenges of adding value in an investment class that's limited to institutions and wealthy individuals presumed to be able to vet fund managers on their own. The Madoff scandal exposed the failures of some so-called funds of hedge funds, which pool investor money to invest in individual managers, prompting investors to tighten due diligence further.

Moody's is better known for its assessments of company and government debt. The unit of Moody's Corp. (MCO) and rivals have been blamed by some for underestimating the risk of default on hundreds of billions of dollars of mortgage debt.

"Ratings firms have been a large problem, as we saw in 2008. Why would they be any better on hedge funds?" said Brad Balter, managing partner of Balter Capital Management, a Boston firm that advises clients on hedge fund investing. "I'd far rather pay attention to our own due diligence on hedge funds than depend on a third party."

Odi Lahav, a Moody's vice president, said the ratings of hedge funds' operations are "fundamentally different" from ratings on structured finance, as they are based on qualitative considerations such as assessments of a fund's governance, valuation policies and trading systems. The ratings don't assess a fund's investment performance or strategy.

Moody's on Tuesday said it revised its ratings approach in part by grouping ratings into five main categories and adding a ratings "scorecard," to present a clearer picture of those factors.

Fimalac SA's (FIM.FR) Fitch Ratings this week set out its own methodology for rating funds of hedge funds, "to provide investors with an independent assessment of an asset management organization's investment management capacity and vulnerability to operational and investment management failures," according to a report from the firm.

Lahav said the firm rates 20 funds managed by nine different groups. These include funds run by Kenneth Griffin's Citadel Investment Group, Steven Cohen's SAC Capital Advisors, Israel Englander's Millennium Management and Brevan Howard Asset Management, founded by Alan Howard. Hedge Fund Research counted more than 9,000 hedge funds worldwide at the end of March.

Funds seeking ratings compensate Moody's for the service, creating a potential conflict of interest the company says is overcome by separating the analytical and commercial sides of the business, among other safeguards.

In February, Moody's announced it had withdrawn operational quality ratings of funds managed by Sorin Capital Management LLC, a Stamford, Conn. hedge fund with $675 million in assets, "for business reasons." Moody's had downgraded Sorin's ratings in December.

Kevin Connors, a Sorin managing director, said his firm initiated the decision to stop getting a rating.

"It was pretty darn expensive, and we were finding the bulk of our investors didn't care about it," he said. The downgrade wasn't the reason Sorin quit the service, he said.

-By Gregory Meyer, Dow Jones Newswires; 212-416-2149; greg.meyer@dowjones.com