Dollar doldrums and LatAm debt dent confidence

ABN Amro's head of alternative investments, Gary Smith, is cautious on the outlook for hedge funds as the dollar falls and a Latin American debt crisis looms.

Smith said in the past there had been a high correlation between debt problems in emerging markets and fallout in the hedge funds industry, a reference to the collapse of LTCM following the late 1990s' emerging markets crisis.

He added that a weakening dollar was also a negative when many hedge funds were holders of US securities. 'At the moment, we are in a relatively high risk environment,' he said.

Overall, he sees continued rapid growth of the hedge fund market as institutions look at investment vehicles that can boost their profitability at a time when the mutual funds industry's margin is under pressure.

ABN Amro estimates a bond mandate can make an institution 0.2% a year, compared with 1% for a retail equity product, about 1.5% for a fund of hedge funds and as much as 3% for a hedge fund, including performance fees.

Smith believes Europe will see the most rapid growth in hedge funds. Roughly 15% of global hedge fund assets are based here, according to ABN, compared with 80% in the US.

He said: 'Europe is growing more rapidly than the US, but off a very small base.'

While global hedge fund assets total $600bn, he believes this still leaves the industry with plenty of scope for future growth, as the US mutual fund industry is $5 trillion and the US pension fund industry some $8 trillion.

ABN Amro believes there are plenty of risks to institutions looking to develop hedge fund capacity. Crucially, building up a star culture with higher remuneration can cause tensions among the fund management team. Another is the complications that might arise in the investment process. Smith gave the example of a long only fund being overweight in a stock the hedge fund wished to short.

Smith added risk monitoring was essential for liquidity and trading, aspects that were less important for long-only funds.

External risks also exist for a business, Smith said. 'You can have brand contamination if one hedge fund blows up,' he said. 'Some strategies will blow up ' it is just a matter of time, so you need to be careful which one you go into.'