Expect Hedge Fund Inflows Of $222 Billion, Investors Say

Mar 16 2010 | 1:16pm ET

Hedge funds are poised to take in more than $200 billion in inflows this year, returning industry assets to near where they were before the economic crisis.

Deutsche Bank, which estimates hedge funds' assets to total about $1.5 trillion, expects the industry to add $222 billion in new money this year, based on its eight annual alternative investment survey. That would leave the industry less than $200 billion short of its 2007 peak of $1.9 billion.

Some 73% of survey respondents expect hedge funds to see inflows of more than $100 billion this year. Almost no one—less than 2% in the survey of 606 investors with more than $1.07 trillion in hedge fund assets—expects a third consecutive annual outflow.

“The industry is now predicted to grow further and return to previous highs,” Deutsche Bank said.

“2009 has proven that market disruptions create great opportunities and furthermore, what a year’s worth of good performance can do for the industry.”

The renewed inflows, which began in the second half of last year, are being greased in no small measure by two factors: Investors have a lot of cash on hand, and expect a lot of good things from hedge funds—and the broader markets—this year.

Much of the inflow is likely to come from cash; Deutsche Bank estimates that investors may cut their cash levels by more than $3 billion over the next six months. According to the survey, 29% of hedge fund investors have 10% or more of their assets sitting in cash.

A plurality of those surveyed—more than 40%—expect their hedge fund portfolios to return between 10% and 15% this year, down from about 20% last year but still a respectable figure. All told, only 10% expect hedge funds as a whole to do that well, but about one-third see returns of 5% to 10%, and another one-fifth expect returns of up to 5%.

Optimism about stocks is almost as strong. Nearly three-quarters predict the MSCI World Index will rise this year, and roughly one-third say the Standard & Poor’s 500 Index will rise between 5% and 10%.

Much investor attention is focused on Asian hedge funds. Almost half of investors say they’ll pour money into Asia ex-Japan funds this year, while the number of those who do not allocate to the region fell to just 13% from 38%. Three-quarters of investors expect to allocate to China this year, and more than one-quarter say they’ll add to their Chinese hedge fund investments this year.

In terms of strategy, global macro funds are expected to have the best year. Equity hedge funds and distressed debt funds are also seen as having a good year. By contrast, volatility arbitrage, commodity trading advisors and convertible arbitrage hedge funds—the latter last year’ best performer—are expected to find themselves at the bottom of the hedge fund performance tables in 2010.

While the difficulties of 2008 have faded to almost a memory, it is a powerful one. While most investors said that less than 5% of their hedge fund investments remained restricted, and almost half said they held no gated funds, four out of five said they would never invest with managers that restricted redemptions or created side-pockets for illiquid assets again.

The economic crisis has also pushed investors into the arms of a smaller number of large hedge funds, according to the survey. But the reticence about investing with small managers has not put much of a damper on seed investors, “still a surprisingly high percentage” of hedge fund investors, according to Deutsche Bank.

About 17% of those surveyed are in the seeding business, down from 20% last year.

Fewer than 20% of the world’s hedge funds are likely to go under this year, according to 80% of survey respondents. Last year, a quarter of investors expected more than 30% to go out of business, and 40% of investors saw closure rates of between 20% and 30%. And the trouble isn’t likely to come from the markets, but from regulators, they say: Half ranked regulation as the greatest challenge for the industry this year.

But the former threat has not fully subsided, according to Deutsche Bank.

“A correction of the equity markets, a blow-out in credit markets or a worsening of liquidity was a possibility in 2009 and still remains a threat for 2010,” it said.

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