Activist: The Bullish Case for Hedge Funds

Here are some other fearless predictions for the industry:

• The number of hedge funds will decrease by 30% between the start of 2008 and the start of 2010, but the assets under management will actually increase as investors seek out the best managers.
• This growth will come at the expense of the mutual fund industry and wealth management.
• The due diligence industry, which researches hedge funds and their managers, will quadruple in size. Today, there are few firms with expertise in this area (Due Diligence Consulting, Kroll and Backtracks are on a short-list of firms with expertise in this area). Investors will need to invest in hedge funds, but won't be able to rely on the Securities and Exchange Commission to conduct their due diligence. They won't mind paying for this work themselves.
• The "2 and 20" fee structure for the industry (under which hedge funds charge 2% annually for management fees and 20% for the share of the profits created) will persist. Investors will not object as long as they receive the performance they expect.
• Fund-of-hedge-funds will be most negatively affected by 2008. Larger institutional investors will become much more hesitant to invest in fund-of-hedge-funds over the next two years in the wake of the Madoff scandal for fear of criticism from their own investors. These types of funds will not go away, but there will only be so many people that can say, "I can get you into John Paulson's fund."
• There will be more hedge fund regulation from Washington but not to the extent that it kills the industry. What purpose would that serve the Obama administration? A greater administrative burden dealing with new regulation will become the new cost of doing business for hedge funds. It will make it harder for newer/smaller hedge funds.
• Hedge fund managers will become better risk managers and learn to perform without the benefit of leverage. Those with enduring strategies that can create value will grow.

Hedge funds are not going away. They're actually going to greatly increase in size over the next five years. The level of dissatisfaction in mutual fund managers and private wealth managers will cause investors to seek out better-performing investment vehicles for their cash. Although there will certainly be changes to the industry as a result of the events of 2008 -- including hedge fund failures in the next six months -- the future looks very bright for hedge fund managers and their investors because their interests are so well-aligned.

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