Pension funds set to drive hedge fund growth

Hedge funds will see continued improvement in capital inflows in each successive quarter in 2010, according to Don Steinbrugge, managing partner of third party marketer Agecroft Partners.

Steinbrugge sees increased allocations by pension funds being the major driver for growth in the hedge fund industry over the next decade.

Hedge funds found it a challenge to raise assets in 2009 despite posting solid returns.

Total assets under management (AUM) across the industry fell around 40% from its peak level and net inflows plunged 95% from previous highs during the first quarter of 2009.

The environment for raising capital improved during subsequent quarters but inflows were still down an estimated 60%-70% from their peak in the final months of 2009.

While investor appetite for hedge funds is recovering, it varies across the different investor segments, Steinbrugge said. He sees pension funds as the most likely to make new investments in hedge funds.

The average US pension fund will increase its allocations to hedge funds from the current level of 2.5% to around 15% by the end of the decade, according to projections by Agecroft.

The company predicts a shift towards single manager funds away from fund of funds as pension funds become more comfortable with investing in hedge funds.

Agecroft sees endowments and foundations as a less lucrative source of capital over coming years.

Many of the larger endowments and foundations already maintain allocations of over 50% to hedge fund managers. Any further growth will be limited given the already large allocations, Steinbrugge said.

He thinks the main opportunity in this sector will be takeaway business. However, smaller endowments may be a source of new business for hedge funds, said Steinbrugge.

Sophisticated family offices will continue to be important investors in hedge funds, he added.

The market share of fund of funds will decrease as institutions go direct, he said, while less sophisticated high net worth investors will not return to the industry in a hurry.

While inflows are set to increase, the asset raising environment in 2010 will remain challenging, according to Agecroft Partners. The competition for capital is stiff and a stricter focus among investors on due diligence remains a hurdle to closing deals.

However, those funds which can cater to the needs of pensions funds could be set for a sustained period of growth, Agecroft predicted.