Where's the evidence for this one? I went googling for "hedge funds underperform" and found an article about how major hedge funds had indeed underperformed the S&P 500 over 2010, but outperformed it over the three-year-period 2008-2010.
That is, of course, how hedge funds ought to work -- smoothing out the dips (2008) at the cost of being slightly conservative in the booms.
They under perform compared to the market as a whole but the people who put their money into a hedge fund don't care about that. They are not able to get the same returns a hedge fund can get on their own.
You also need to think about opportunity cost. While many smart people can do the research and figure out how to maximize returns, often it's worth the lower return to to have to worry about it. The time you would spend micro managing the investment just may not be be worth it to many people. Their time is better spent doing other things.
That is, of course, how hedge funds ought to work -- smoothing out the dips (2008) at the cost of being slightly conservative in the booms.