Hedge Fund Sector Reaching Early Maturity, Says New Report

by Phillip Morton, Investors Offshore.com

06 July 2005

the recent unprecedented surge in the demand for hedge funds will ease as the industry 'commoditises,' according to a new study published by CREATE, a UK think tank, and KPMG International.

The study presents the views of 550 top executives in 35 countries involved in hedge funds, their administration, prime broking, mainstream fund management and pension funds with combined assets worth US$23 trillion. It shows that the worldwide growth in hedge funds has been fuelled by the prolonged bear market and the inflow of top talent capable of generating high returns. However, their impact has been diluted as the number of start-ups has increased considerably.

The report finds that the quality of the resulting capacity is highly variable with most of it, as yet, incapable of generating the high double digit returns that investors are led to expect. In addition to poor returns, another big risk from market saturation is seen at the administration end with the potential mis-pricing of complex products.

Commenting on the report, Professor Amin Rajan, the report’s principal author and the CEO of CREATE observed that: “About 15 percent of hedge fund managers are stars with a proven track record; but they are unwilling to grow their business substantially for fear of diluting the returns. A further 55 percent are wannabes with the right pedigree; but they are neither tested nor stretched. The rest are the victims of the brutal burn and churn that characterise their industry.”

The study predicts that the next wave of new money into hedge funds will come from pension funds, with those in the USA expected to have bigger allocations than their peers in Europe and Asia Pacific due to superior in-house expertise and oversight controls.

However, the report predicts that worldwide, allocations will be small, making up less than 3% of total investments on average. But the sheer weight of new money should commoditise hedge funds and drive down high charges and fees.

According to the report, there is already evidence that hedge fund managers and mainstream fund managers are diversifying into one another’s product areas, using similar investment strategies and boutique structures that overtly separate high and low return products, meaning that hedge funds are no longer the only vehicle for achieving high absolute returns in today’s low volatility environment.

“Gaining huge prominence in the bear market, hedge funds will outlast it; as will their top managers," noted Tom Brownco-author of the report and partner at KPMG in the UK.

"As a catalyst, they have started a chain reaction that extends across the global fund management industry. They have forced mainstream fund managers to go back to their time honoured mission to provide absolute returns," he added.

The study predicts that the hedge funds industry will consolidate over the next three years because of a wide margin of under-utilised capacity, at the manufacturing, distribution and administration end. It concludes that the contours of the fund management industry will change by 2010.

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