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The hedge fund industry may have bounced back from its nadir in early 2009, but 2010 has been far from easy. This has been a year when hedge funds were given a choice to adapt to a changed economic and political reality – or fall into decline.

Undoubtedly, though, the industry is here to stay – a notion that was far from certain only 12 months ago.

At present, hedge funds globally manage an estimated $1,700bn in assets across more than 7,000 funds, according to Hedge Fund Research.

In the words of one London-based consultant: “There will always be a place for asset managers that can deliver outsize returns … and there will always be investors or institutions willing to pay the fees for them.”

The industry has regained much of its former clout. Hedge fund managers are still regarded as the savviest and most influential figures in the world’s markets – though not always in a positive light.

When the Greek sovereign bond crisis struck earlier this year, for example, politicians were quick to finger hedge funds as the culprits – even though they were not to blame. And when Cadbury was taken over by Kraft, the US food conglomerate, hedge funds were also accused of having greased the deal by buying up nearly a third of the UK confectioner’s stock.

Once, hedge funds could afford to shrug off criticism about the role they play in the markets. But in the current political environment, popular outrage is readily translating into punitive regulation.

In Europe, for example, the proposed Alternative Investment Fund Manager directive threatens to subject hedge funds to an onerous new regulatory regime. Hedge funds are only just realising that the next few years may require them to be as politically sure of foot as they are financially.

The irony for the industry is that changes – often tough and far-reaching – are already being self-enforced, without dictats from Brussels or Washington. In the wake of the Bernard Madoff scandal, and the losses suffered by some funds in 2008, hedge fund investors have become bolder and more exacting in what their managers do with their money, and have been the primary force of change in the industry.

One trend set to continue, for example, is the use of so-called managed accounts, where large clients can demand that managers segregate their investments in vehicles separate from the main fund. In such circumstances, the investors, not the fund manager, retain ultimate control over the assets in their separate accounts. Since 2008, according to a recent research paper by Barclays, 30 per cent of hedge fund managers have launched separate managed accounts for big-ticket clients.

In addition, more than 80 per cent of those accounts use investment strategies that are tailored to fit client specifications and that do not simply replicate managers’ existing fund strategies.

Such changes reflect the growing significance of institutional investors. Whereas once investment in hedge funds was the preserve of the super-wealthy, the industry is coming to be dominated by investments from pension funds and insurance companies looking to diversify and bolster their portfolios.

Indeed, attracting institutional investment is now the holy grail of hedge funds, not least because such money tends to be far “stickier” and less flighty than money from private banks and wealthy individuals.

As a result, managers themselves need to become more institutional, which means establishing risk-management systems, risk committees, independent boards of directors, and powerful oversight mechanisms. Gone are the days when two men in Mayfair with a Bloomberg terminal were able to attract investors’ millions.

It is not just the larger managers that are changing, either. According to Barclays, almost 20 per cent of assets managed by firms smaller than $1bn now comes from institutional investors, compared with just 8 per cent in 2008. In January, for example, Finisterre, the fund specialist, had roughly $650m of assets under management, and then received a $250m mandate from New York’s state pension fund.

This trend towards institutional dominance of the industry shows no sign of abating.

Speaking earlier this year at the GAIM conference in Monaco – one of the industry’s biggest annual gatherings – Yariv Itah, a partner at Casey Quirk, the research consultancy, predicted that total assets under management in the hedge fund industry would surge to $2,800bn in the next three years, an increase of 65 per cent.

The single largest group of investors, he concluded, would be retirement schemes.

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