Insight - Over the hedge.

(From Financial Director)

Byline: Richard Willsher.

There are about 8,000 hedge funds worldwide managing in excess of $1 trillion (GBP555bn) worth of assets. This is before adding in the leveraging raised on the back of core holdings.

The soaring growth in the sector is set to continue, according to LJH Hedge View, an industry newsletter published by Florida-based LJH Global Investments LLC, which projects that hedge fund assets could reach $4 trillion (GBP2.22 trillion) by 2010.

These would be large numbers in most people's book, but analysts at JP Morgan Securities calculate that, in the context of the world's equity and bond markets together with total bank lending, hedge funds appear to account for less than 1% of the world's financial assets and so are still a niche area. But among other things, JP Morgan's research concludes that, "As they grow larger, (hedge funds) will eventually erode the same market opportunities and mispricings they have relied on to create their superior returns. Opportunities are disappearing fastest where hedge funds are active, where there are deep derivative markets, and where the same trading rules have been used for some time."

Pension fund trustees might find this emerging situation alarming. After all, the whole attraction of a hedge fund is that it can achieve superior returns because it is smarter and fleeter of foot than the average mainstream fund manager. Most people put up with their lack of regulation as part of the price paid for the upside. But not only is the upside disappointing and the fees high, they seem about to ramp the very markets from which they reap their benefits.

Added to this, more hedge funds are now trying to give themselves greater time and increased stability by requiring their investors to accept longer lock-ins. Morgan Stanley's Huw van Steenis and Bruce Hamilton have identified a significant number of hedge funds that have set up "long only absolute return funds". These require investors to maintain their investment in the funds for, say, 12 months or more, rather than being able to liquidate their positions on a quarterly or six-monthly basis.