A negative market environment and the impending introduction of the AIFM directive will create challenges for hedge funds and fund of hedge funds next year but creative funds will survive.

The negative economic environment will continue into next year and regulations will create further challenges for hedge funds but there will be also be opportunities.

"Unfortunately the industry doesn't work in isolation from the real world," says Ian Morley, senior consultant at Allenbridge. "We are speaking now before we know the resolution of the euro situation."

While there is a high chance of the economy tipping back into recession, according to Morley, he says the 'beauty' of the hedge fund industry, is that "just when everyone else is exiting, we will take that risk", which is where there are opportunities, he adds.

Other challenges for the industry will come in the form of the AIFM directive. "My concern about some of the directives that have come out of Europe is they start from a position of prejudice, and I think the industry has done as good a job as was possible to knock back the really badly thought-through ideas, but overall certainly some of these directives, and the AIFM directive, I think are generally regressive, expensive, bureaucratic," says Morley.

The solution, he says, is to be proactive and for the industry to engage in dialogue with the regulator.

Investor due diligence is important but hedge funds and funds of hedge funds also need to be careful not to oversell, according to Morley. That was the problem in 2008, he says, "Because [investors] thought hedge funds would never lose in any market conditions. That's not true, that's what I mean by an element of mis-buying and mis-selling.

Although he thinks the markets will continue to create a tough environment, funds of hedge funds will keep their investors if they are creative enough, says Morley. "It's very Darwinian. Those that are creative enough will, and those that aren't won't."