More Warnings About The Future For Hedge Funds

by Carla Johnson, Investors Offshore.com

28 March 2005

New voices were added last week to the recent chorus of doom-mongers warning that hedge funds cannot continue to deliver benefits to an ever-increasing universe of investors, with both UBS and consultants Watson Wyatt issuing cautionary reports.

Watson Wyatt's report focuses on the quality of hedge fund management, estimating that out of around 6,000 hedge fund managers, only 5% to 10% are skilled enough to be able to add significant value after fees are allowed for. "We estimate that our top-rated fund of hedge fund managers account for roughly 8 percent of the market," the report said. "Taking only our estimate of the assets of highly skilled hedge fund managers, $225-$450 billion, these funds of hedge funds would account for about 15-30 percent of the top talent."

Watson Wyatt also says there are capacity constraints in the hedge fund market: “It follows that a lot of investors in hedge funds are going to be disappointed.”

Investment bank UBS issued an 80-page research report pointing out that generating alpha is becoming more difficult: “Expectations of future hedge fund returns could be – as possibly every other investment historically (real estate, equities, tulip bulbs, etc.) – too high, and potentially a source of disappointment.”

Johan Ahlstroem, head of Allianz AG's unit Allianz Hedge Fund Partners, says the hedge fund boom of 2004 is not expected to continue this year. While he thinks that the German hedge funds market will continue to grow this year, he does not expect to repeat last year's strong growth, where $800 million investments in four Luxembourg umbrella funds boosted the hedge fund unit's total managed assets to $1.4 billion.

Still, neither UBS nor Watson Wyatt is recommending a rush for the exits. Watson Wyatt says that hedge funds are still likely to return enough to improve the efficiency of an institutional portfolio. "We believe that there is still room for returns to come down from historic levels before the case for investing in hedge funds is no longer supportable," the report said. "Looking ahead, we believe that a return of Libor plus 4-5% per annum net of fees is a reasonable expectation for a highly skilled fund of hedge fund manager that manages growth well."

Recommended