Freeman Points Out Fund of Funds Growth and Hurdle

NEW YORK ( in funds of funds have grown faster than anticipated, but challenges remain for the sector, according to Freeman & Co.'s latest industry research.

The firm estimates that the fund of funds sector of the industry grew to US$179 billion in 2002 up from the US$79 billion in 2000, which means that Freeman's original estimates of assets under management by 2005 of US$260 billion were unrealistic. The market research firm's estimate of 13% growth from 2002's assets required to reach the original estimate of US$260 billion in assets would be selling the industry short, given the momentum the hedge fund industry has maintained in recent years and months, according to researchers.

Industry growth rates of 15% to 20% seem much more realistic, according to Freeman officials, who estimate asset performance to remain at 6% to 8% and incremental allocations to remain steady at 7% to 14% of assets. If the Freeman authors are correct, the fund of funds portion of the industry will grow to total between US$272 billion and US$309 billion in 2005.

Most of that growth will be at the larger funds of funds. Freeman estimates that the top 25 firms have on average 2.7 times the level of assets of the next 25 largest firms. "We expect this figure to continue to rise as the largest firms have competitive advantages in terms of building risk systems, developing structured products, developing new distribution channels and expanding globally," the Freeman researchers wrote.

Freeman said that the average US$4.8 billion fund of funds firm today should have an average of US$7.2 billion in a few years, while smaller firms could grow from US$760 million to US$1.7 billion to total US$2.3 billion in three years. The large number of new entrants might be contributing to smaller average size of the smaller firms. Also, Freeman officials have spotted a number of firms with US$10 million to US$50 million in assets that might not survive the next three years.

The expansion of hedge funds and funds of funds in particular nonetheless will continue. Two trends are driving the growth, according to Freeman. The first trend is the creativity of Wall Street's sell side and buy side and, secondly, the institutional investor's appetite for hedge funds. In its previous report that was on the fourth quarter 2002, officials predicted continued institutionalization of the hedge fund industry .

In the future, Freeman believes that more firms will develop multi-product alternative asset management platforms to leverage marketing and distribution channels and to diversify revenue streams. Firms such as Blackstone Alternative Asset Management and Credit Suisse are good examples of this--both leveraging their alternative asset management business as part of their overall asset management operations and cross-selling their offerings, the most recent Freeman report stated.

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