HEDGE FUNDS MUST strive to keep up with returns offered by the cash equity markets this year if they are to continue to attract funds at the same rate as in 2003.
Moving into hedge funds in 2001 and 2002 was a good way for smart investors to preserve their money in a bear market. In 2003, though, even as the industry enjoyed record inflows estimated at $60 billion by Tremont's Tass Research, hedge fund indices underperformed the S&P500.
To compete this year if cash equity markets keep rising, hedge funds must focus on product innovation and the development of new strategies.
Among those now emerging are credit long/short, a quasi-private-equity approach and what are called new alternatives, such as weather derivatives and catastrophe bonds. Another tactic for hedge fund managers may be to seek flows of money coming out of bond allocations.
Most hedge fund managers expect the equity markets to continue to thrive in 2004. It follows that the hedge fund strategies with the best prospects tend to be those that did well in 2003, for example, event-driven strategies and global macro.