The differences between hedge funds and more traditional funds are likely to eventually vanish, although further EU rule changes will be required, according to the head of British-based Polar Capital Partners.
Mark Kary, chief executive of Polar, which runs $2.8 billion of assets in both traditional and hedge funds, said the two types of fund will ultimately merge as traditional funds use more and more hedge fund techniques.
"I ultimately believe equity long-short and long-only will merge," Kary told Reuters in a recent interview. "(Hedging) is simply a risk management tool for running equity portfolios ... I think the industry will change, but it will take quite a while to change."
Hedge funds aim for positive returns in all market conditions, often using their ability to short sell - or borrow a security and sell it on the expectation of buying it back at a lower price in the future. They often charge higher fees than traditional funds.
In contrast, traditional funds tend to go long (buy and hold) or sell something they already own. Their performance tends to be more correlated to overall stock market performance, and their fees tend to be around half a percentage point.
However, the rollout of new European Union "fund passport" rules (known as UCITS III or Undertakings for the Collective Investment of Transferable Securities) in recent years has begun to blur these boundaries, for instance by allowing traditional funds to use certain derivatives.
Some traditional bond funds have already taken up these hedge fund-like tools to help protect assets in tough market conditions.
However, Kary said further rule changes are required because current EU rules do not provide funds with adequate powers to go short or take an especially large position in another fund or asset.
"I'm not sure how it (the merger of long-short and long-only) will happen. UCITS III is a halfway house ... It's definitely not as flexible as a hedge fund ... You really need UCITS IV."
As well as using these new tools, some traditional funds have adopted the practice, common amongst hedge funds, of charging performance fees.
Kary also said investors will allocate more to hedge funds in the coming years because the strong stock market performance of the past three years is unlikely to be maintained.
"I do think allocations to alternatives, specifically hedge funds, will increase," he told a conference organised by brokerage Bridgewell Securities.
"Hedge fund allocations have quietened because the equity market has risen, but I assume the equity market will have a slightly tougher time in the next two years," he said. Investors' allocations to hedge funds slowed last year at a time when stock market performance was strong, although inflows have since picked up.