The phenomenal growth in hedge funds across the world is expected to slow down for the next three years according to a report by KPMG. In the last three years, hedge fund growth has been driven by an equity bear market, increasing investor interest and the talented investment managers bringing in higher absolute returns.

There is still a significant growth expected over the next three years, but it will be at a slower pace, the firm said. Senior Manager of Alternative Investments at KPMG, Anthony Cowell, said there will be a natural slow-down as more investment managers enter the market and compete for high returns. “Historically, investment managers were providing benchmark returns,” said Mr Cowell.

“But the hedge funds industry has forced traditional investment managers to provide absolute returns.

“Now the hedge fund industry is starting to merge with other industries such as the investment management industry. As a result, returns will likely fall as more institutions come into the industry for the next three to five years.” Mr Cowell added that this was already evident as more money comes into the industry.

“In our interviews (for the KPMG report), it became apparent that a few large pensions are beginning to make small allocations, about one percent into hedge funds. This amount is relatively small for the pension fund, but it is huge in monetary terms for the hedge fund industry.

It is like an elephant trying to get into a bathtub. The infrastructure to support it simply isn’t quite there yet,” he said. He explained that because there are more investment institutions competing for absolute returns, star managers have to devise new trading strategies in order to make money.

“Some of these innovative products, which we are seeing, include weather derivatives, freight derivatives and structured product combinations,” Mr Cowell noted. “The key to making double-digit returns is the ability to find the opportunities before everyone else does.

“The hedge fund industry is at an inflexion point. However, it is becoming clear that as a catalyst it is transforming the traditional investment management industry as never before. “For traditional managers, they need to resist mental bungee jumps that bring them back to their old ways - hugging benchmark returns. They need to search for alpha (absolute returns).

“We are beginning to see return compression as the industry becomes institutionalised and there are simply not enough innovative strategies to support the flood of money from pension funds,” he said. The KPMG report stated that hedge fund managers and administrators are still expecting double digit growth whereas pension funds or mainstream fund managers are more conservative in their estimates. The KPMG report stated that bullishness is highest in the US, followed by Asia Pacific and then Europe.

shurna@caymannetnews.com