Institutions To Pile Into Hedge Funds, Says BONY

by Carla Johnson, Investors Offshore.com

17 October 2006

Despite recent disasters such as Amaranth, institutional demand for hedge funds will triple by 2010, according to a new study released yesterday by The Bank of New York and Casey, Quirk & Associates LLC. And there are signs that regulators may increase their oversight of the sector.

The study, entitled “Institutional Demand for Hedge Funds 2: A Global Perspective,” found that by 2010 institutions investing in hedge funds will increase to nearly 25% of all institutions, up from 15% today, representing a more than 60% increase. Retirement plans globally will account for the vast majority of asset flows, with corporate and public pension plans in the United States accounting for the largest percentage increase overall.

“Broadening acceptance of alternative investments coupled with lower expected returns from traditional investments are driving demand for hedge funds among global institutional investors,” said Brian Ruane, executive vice president at The Bank of New York. “Institutional investors are increasingly recognizing that hedge fund allocations have provided significant diversification benefits while delivering the net returns they require.”

The study found that the vast majority of institutions investing in hedge funds use either fund-of-hedge funds exclusively or the “dual approach” model – accessing hedge funds concurrently through fund-of-hedge funds and direct investments. Fund-of-hedge funds will remain the starting point for the majority of institutions initiating a hedge fund investment program. The study predicts that half of global institutional flows will go to fund-of-hedge funds with the other half going to direct investments over the next five years.

Perhaps pushed by institutions wanting to reduce the risks of their hedge fund investments, a number of senior US regulators, both in Congress and at the SEC, are moving in the direction of stricter regulation, although the courts' demolition of the SEC's registration plans earlier this year should hardly give them encouragement. On the other hand, a bad result for Republicans in mid-term elections, now seeming more likely than not, may open the flood-gates to a tide of restrictive Democrat-inspired legislation. Perhaps the President will finally get to use his veto!

Casey, Quirk & Associates LLC provides management consulting services exclusively to investment management firms. The firm specializes in developing business strategy and planning, enhancing investment practices, and crafting distribution policies. Casey, Quirk draws on 35 years of experience in delivering value to its clients and partners through a unique combination of deep industry knowledge and experience, solutions-oriented thought leadership, and a proven ability to create change within organizations. Additional information is available at www.cqallc.com.

The Bank of New York offers a broad array of accounting and administration, execution, cash management, collateral management, custody and asset management services to the hedge fund industry. It has more than $75 billion in hedge fund assets under administration.

Recent weeks have seen bad news from a number of hedge funds. Apart from the high-profile US$6bn loss by Amaranth, which now seems likely to liquidate itself, a large fund run by Vega Asset Management Partners is said to have lost 25% of its value in the last two months. Vega managed a total of more than US$10bn in 2004, but reportedly now has less than US$6bn under management. Of course, that may be due to redemptions, not losses. Who knows?

Vega's recent losses are thought to have been incurred on short positions in sovereign bonds, and a bet that the Japanese yen would appreciate against the euro.

Investor sentiment favours larger fund managers, such as the highly successful Man Group, and many observers say that a period of consolidation is likely as smaller, weaker funds run for cover in the arms of their larger peers.

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