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Institutional investors provide a force for change

Following the negative asset flows experienced by the hedge fund industry during the final quarter of last year, 2006 got off to a promising start with strong inflows during the first quarter. The downturn always appeared a temporary phenomenon owing more to the passing attractiveness of equities and, to some extent, a rebalancing of portfolios by larger investors,  rather than any wider dissatisfaction with hedge funds as a whole. Indeed, the majority of new products from our clients in the first quarter of 2006 were strongly subscribed from launch. With performance also robust during the first quarter, the coming year should be fertile for all industry participants.

In the future institutional investors should be an increasing force for change within the alternative asset management industry. Transparency in relation to underlying holdings has always been a big issue for institutional investors, and this trend is set to extend to performance as educated investors increasingly question what proportion of their returns are down to alpha as opposed to alternative beta. This provides an opportunity for service providers to prove their worth by creating and mapping trade files for upload and analysis through their clients' software, or through the direct provision of technology for the end user.

Another trend driven by larger institutional investors is the extent to which alternative assets are now being held or managed outside the classic fund structure. We are receiving an increasing number of servicing requests from institutional managers looking to capitalise on this trend and build or operate their own managed account platforms. From an investor's perspective the benefits include segregation of assets, heightened transparency and the opportunity for more customised mandates, although not all strategies are suitable for managed accounts and the minimum fees can render them unattractive at the lower end of the market. Service providers need to be aware of this trend and HSBC has already invested considerable time in building a scalable product offering for this sector of the market.

The return to form of private equity fund raising during 2005 should continue this year as investors move down the liquidity spectrum in search of higher returns. HSBC is well placed to capitalise, having invested significantly in a dedicated private equity administration platform. As convergence between hedge and private equity funds increases, we have received several  requests to service hybrid structures this year, and their increasing prevalence means fund administrators will have to learn to adapt to the unique challenges they present.

The M&A activity evident in the wider marketplace has yet to filter through to the alternative asset management industry to any significant degree, and the current trend sees the  institutional purchase of large bluechip  fund of funds managers rather than any serious activity in the single manager sector. However, it may be that just as institutional investors first sampled the hedge fund industry by investing in funds of funds, institutional managers are now sampling the sector and acquiring them. It remains to be seen whether the acquisition of  eminently  more scalable fund of funds managers is a prelude to a wave of single manager acquisitions.

By Tony McDonnell - head of business development for HSBC's Alternative Fund Services in Dublin

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