By Francis Chan
THE global assets of hedge funds could fall by 35 per cent as fund managers dwindle and leveraging strategies becomes harder, according to Swiss bank UBS.
The dire forecast follows a 21 per cent drop in a key guide that tracks fund performance - the Hedge Fund Research Fund of Funds Composite Index.
'We would estimate that hedge fund assets by the end of this quarter will have fallen to about $1.2 trillion: that is a decline of 35 per cent from its peak of 2007,' said managing director of UBS Wealth Management, Timothy Bell on Tuesday.
Hedge fund assets totalled about $1.9 trillion during the boom of 2007 to mid-2008 but they have since tumbled to $1.4 trillion by the end of last year.
Mr Bell said there were signs of a reduction in hedge fund assets but he expects a further decline as investing strategies based on leveraging - or borrowing - will not work in today's tight credit markets.
'There isn't much leverage available and if there is, it will be expensive,' said Mr Bell. 'We're going to see better terms for investors...the balance of power is swinging away from the hedge funds towards investors.'
The causes for the industry's worst year on record are well-known: the collapse of Lehman Brothers, the recall of financing lines from prime brokers, global de-leveraging and a ban on short-selling.
However, this year started well for hedge funds as they outperformed fast-declining stock markets last month.
Mr Bell also expects other fundamental changes to the way the industry operates, starting with the regulatory regime.
'We're inevitably going to see increased regulation and that, of course, is going to be in the financial industry at large,' he said.
'You can't expect if governments are owning substantial positions in banks that they will not increase regulation, and that will have a knock-on effect in all parts of the financial markets including hedge funds.'
The industry contraction can actually benefit hedge fund investors as there is now less capital and better fund managers chasing opportunities, said Mr Bell.
'From an investor point of view, this is actually quite good news,' he added.
'There're opportunities right now with $8 trillion of liquidity pumped into the system by governments, you're seeing systemic risks being reduced and so assets are finding their intrinsic values thus helping the hedge funds.'