The hedge fund industry will set a record for assets this year despite the sector's lackluster investment performance over the past two years, according to predictions by Agecroft Partners, a global consulting and third-party marketing firm for hedge funds.
Agecroft based this conclusion on several dominant and emerging trends it identified through its contact with more than 2,000 institutional investors and 300 hedge fund organizations during 2012.
1. Pension funds will drive growth in the hedge fund industry in 2013
As many pension funds face massive unfunded liabilities, they will continue to increase their allocation to hedge funds in order to enhance returns and reduce downside liabilities, Agecroft predicts. Forward-looking return assumptions are currently around 3% for fixed-income portfolios managed against the Barclays Aggregate Bond Index, which currently represents approximately 30% of pension funds' total assets. With current actuarial return assumptions averaging approximately 7.5%, pension funds will shift more assets from fixed income into hedge funds as long as interest rates stay low.
2. Pension funds' hedge fund investment process will evolve more rapidly
Actuarial pressures are forcing some bigger pension funds to accelerate their hedge fund investment process. Pensions used to tiptoe into hedge funds, taking a decade or longer. They would start with an investment in a fund of funds, followed by hiring a consultant and investing in brand name managers. As their experience increased, the process would move in house, with internal teams making independent decisions and focusing on "alpha generators." Finally, the process would evolve into a best-in-breed strategy of investing, with hedge funds no longer considered a separate assets class, but incorporated throughout the portfolio.
Time is now a luxury, and some bigger pensions are skipping the fund-of-funds roundabout and investing directly in individual managers. This, in turn, has long-term implications for funds of funds. 
3. Funds-of-hedge-funds industry continues to evolve
The FoHF marketplace is approximately 25% smaller than at its peak in the third quarter of 2008, and fee income has declined by more than 50%, owing to downward pressure from large institutional investors. Agecroft predicts that in 2013, FoHFs will experience slight net redemptions as withdrawals by the largest pension funds choosing to invest directly in hedge funds will be partially offset by smaller institutional investors increasing their allocations to funds of funds and new high-net-worth individuals entering the space.
Agecroft also looks for further bifurcation in the FoHF sector, with a few firms growing their asset base and others experiencing large net redemptions. The successful organizations will include large multistrategy funds of funds with strong performance that can justify their fees by clearly articulating their competitive advantage over hedge fund consulting firms, and niche FoHFs that differentiate themselves by focusing on a specific strategy, region, fund structure or investor type.
4. Passage of JOBS Act will change hedge fund marketing strategies
The JOBS Act will help level the playing field within the hedge fund industry by giving investors greater transparency, according to Agecroft. Many hedge fund websites will provide detailed information on their organization, investment team, investment process, risk controls, performance and service providers. More managers will participate in industry databases, making it easier for investors to identify and compare managers within a strategy. Investors will also benefit from more hedge fund managers being interviewed in the media about their hedge fund strategies and investment ideas.
