Hedge funds may struggle to make strong returns in future as a flood of new investment inflows dilutes opportunities for strong performance, senior executives from US university endowment funds said on Wednesday. The industry may struggle to fulfil clients' expectations due to the weight of money coming into the sector, Jonathan Hook, chief investment officer of Baylor University, told an International Centre for Business Information conference.
"There seems to be a supply and demand imbalance at this point with too much money flowing into spaces where the opportunity set is not as robust as it has been. Not a lot of things look really good right now," Hook said.
Hedge funds, which typically need price volatility and clear market trends to make money, have flagged for much of this year due to sluggish stocks, an unexpected fall in bond yields and a dearth of convertible bond issuance.
Billions of dollars have flowed into hedge funds from institutions like college endowments in recent years as investors have looked for alternatives to stocks and bonds. Hedge funds are estimated to control about $1.0 trillion of assets world-wide although they are dwarfed by the overall world capital market.
The Baylor University endowment fund holds a total $700 million in assets, of which 30 percent is in alternative investments which include hedge funds and private equity. The exposure to alternative investments may rise to 40 percent next year with the hedge fund element rising to 15 percent of all assets, Hook said.
But he accepted that it was difficult to find the most promising hedge fund sectors. "We are probably trying to find a niche. It is forcing us to take a lot of time and spend effort to find which managers we would like to add," he said.
Michael Hennessy, vice president and co-founder of UNC Management Co, part of the University of North Carolina, said he was also concerned whether hedge funds could continue to deliver acceptable returns. The university's $1.2 billion fund holds 60 percent of assets in hedge funds.
"Our main worry is that will hedge funds give us they return that we need? If returns start narrowing between traditional investments and hedge funds, then some constituents (clients) may put more pressure to use less hedge funds," he said.
In September, returns for hedge funds were just over one percent, according to data from the Credit Suisse First Boston Tremont Index. But in the nine months to end-September returns were only 3.0-3.5 percent.
Cathy Iberg, deputy chief investment officer for the University of Texas Investment Management Company, said her main fear was that the hedge fund market was due a shock, possibly stemming from levels of borrowing, or "leverage," or from some other source.
"The biggest worry we have is that we are due for something to happen in the marketplace," Iberg said.
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