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For Hedge Funds, It Pays to Be the Biggest or the Best

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Hedge fund assets will grow at a 7% clip in 2014, surpassing $3 trillion by year-end, according to a Deutsche Bank survey released Tuesday.

The study found that 39% of institutional investors planned to increase their allocation to hedge funds this year.

Deutsche polled 435 hedge funds investors from 26 countries, representing $1.8 trillion in assets under management, of which about half of respondents managed more than $1 billion and a fifth more than $5 billion.

Firm size matters. Since 2008, the survey found, assets managed by $5 billion-and-larger firms grew by 141%, compared with 53% for those with less than $5 billion.

At present, 200 firms at most account for more than two-thirds of industry assets.

Manager skill is also critical as the gap between top performers and laggards widens. In 2014, the top fifth percentile of hedge funds returned more than 22%, compared with the average hedge fund return of 3.3%.

Investors told researchers they were looking for steady and predictable risk-adjusted returns — a sentiment reflected in other research. Only 14% said they still targeted returns of more than 10%, compared with 37% that did so a year ago.

At the same time, 40% of respondents said they now co-invested with hedge fund managers in order to increase their exposure to a manager’s best ideas.

Seventy-two percent of these investors said they would increase their allocation in 2015.

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Opportunities Ahead

About one in three respondents said they planned to increase their investment in quantitative strategies, which generated strong returns last year — chasing performance, some observers would say.

The three most-cited quantitative strategies by respondents were commodity trading advisor, quant equity market neutral and quant equity.

Asia beckons as well. Thirty percent of allocators, up from 19% a year ago, said they would increase investment in Asian managers over the next 12 months.

China and India will benefit, with 25% of respondents seeing opportunity in the former, up from 11% last year, and 26% planning to increase exposure in the latter, compared with just 4% a year ago.

The survey found that intermediaries were playing an increasingly important role, as big, well-resourced players saw strong demand from institutional investors.

Thirteen percent of fund-of-funds respondents managed 55% of that segment’s assets, while 28% of investment consultants accounted for 89% of total hedge fund assets managed or advised by their counterparts.

“As institutional investors’ needs continue to evolve, they are increasingly looking to work with larger hedge fund managers and intermediaries who can meet their appetite for comprehensive portfolio solutions,” Barry Bausano, co-head of global prime finance at Deutsche Bank, said in a statement.

“More and more, we’re seeing today’s hedge fund assets concentrated among the largest managers.”