Analysts Predict Squeeze In Hedge Fund Market

by Phillip Morton, Investors Offshore.com

14 February 2005

Analysts are predicting that some hedge fund companies will be forced into mergers - or forced out of business completely - as an increasing number of new firms anxious to tap into the apparently insatiable investor appetite for hedge funds chase diminishing profit opportunities in an overcrowded market place.

While estimates of the size of the hedge fund industry vary, it is generally accepted that there are now around 7,000 hedge funds managing assets in the region of $1 trillion, and the industry has undergone phenomenal growth in the wake of the stock market crash at the turn of the century.

"It's getting very tight as more and more join the game. More people chasing the same trades makes it difficult, especially as markets become more and more efficient. Leverage funds are going to hurt," observed Ross Leckie, director at fund manager Martin Currie, according to Reuters.

Hedge fund returns averaged around 9% last year, down from 15% in 2003. They were also outperformed by the major equity benchmarks.

As more participants have made markets more efficient, the growing size of the hedge fund industry has become a particular problem for funds that specialise in arbitrage trades which exploit inefficiencies, or price misalignments, between two related assets.

What’s more, analysts believe that the year ahead will also be tough for hedge funds as managers seek to extract higher returns through increased leverage. With the prospect of further interest rate rises in the US this year, the increased cost of borrowing to finance trades will put additional pressure on managers to come up with the goods.

However, that said, some market watchers believe global macro funds, the traditional hedge fund hunting ground in the 1980s and 1990s and which use leveraged directional bets on the currency, commodities, interest rate and equity markets, will be the winners in 2005.

"Leveraged trend-followers will be top performers this year. They won't have a risk-reward palatable to all investors, but that's where most of the new money will go,” one analyst told Reuters.

Recommended