In 2001, the Art Institute of Chicago lost $43 million of its endowment in fraudulent hedge funds. Shocking as it was, that scenario might become more common as nonprofit organizations sink more money into these unregulated investment pools.

In the last three years, the $2.3 billion Duke Endowment changed its portfolio to reduce dependence on equities by increasing its assets in alternatives, including hedge funds. The $1 billion Catholic Healthcare Partners, a nonprofit health system, is now...


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