Hedge fund assets to grow 75% by 2008, TowerGroup predicts

New research from TowerGroup predicts that combined hedge fund assets, those of single hedge funds and funds of hedge funds, will increase at a compound annual growth rate of 15% between 2005 and 2008 – resulting in overall growth of 75% in hedge fund assets over this period.

Hedge funds have moved increasingly into the spotlight as a broader spectrum of investors look for vehicles to beat average market returns. In the coming years, hedge funds will become more mainstream as institutions increase allocations to alternative investments, funds of hedge funds proliferate, and new retail investment products lower the barriers to hedge fund entry, it says. TowerGroup finds this changing client base of the hedge fund market, along with its significant growth trajectory, will drive new opportunities and challenges for service providers to the industry.

“The changing client base of hedge funds, their use of multiple prime brokers, and increasing regulation by the SEC are all driving demand for better technology and transparency,” said Matthew Nelson, analyst in the Investment Management research practice at TowerGroup and author of the research. “Fund administrators must quickly broaden their technology capabilities and service offerings to keep pace. At the same time, battle lines are being drawn as prime brokers push into hedge fund administration, and global banks acquire traditional fund administration providers.”

While hedge fund assets are in for significant growth, the actual number of hedge funds themselves will remain relatively flat, the firm predicts. Growth in the number of hedge funds will slow to a compound annual growth rate of 1% through 2008, the result of a slight increase in the fund attrition rate, currently at 5%, coupled with a decline in the number of new fund entrants due to heightened SEC oversight, it says.

By 2008, as hedge fund assets cross the US$2 trillion mark, TowerGroup expects more than US$2.5 billion to be spent annually on hedge fund administration services alone.

And, it suggests that both hedge fund administrators and prime brokers will, in turn, increase spending on the technology needed to support hedge fund business. TowerGroup expects fund administrators to invest US$250 million in technology in 2008, up from $144 million in 2005. Technology spending by prime brokers will reach US$900 million in 2005, and is expected to top $1 billion in 2008.

While the crumbling wall between prime brokerage and fund administration will impact the entire servicing landscape, prime brokers looking to grow their hedge fund business face specific challenges, it adds. These include intensifying competition, internal operations still “siloed” across lines of business, legacy IT applications, and the effectiveness of their approach to risk management.

“The demand for transparency across all aspects of hedge fund management represents a good opportunity for both fund administrators and prime brokers, if they invest today in the best people and the technology to handle the coming growth and diversification of the market,” said Nelson.