AS EQUITY markets bounce back, hedge funds are being left behind. In the second quarter of 2003 hedge funds returned just 9 per cent, compared to 18 per cent from the average offshore equity fund.But hedge fund managers claim that they are not feeling any pressure.

Stanley Fink, chief executive of Man Group, says: ‘We’re not in the market of providing dramatic returns – what we want to do is provide a safe absolute return, even when markets are going down.’ Fink’s group manages more than $30 billion of assets.

Hedge funds have been around in various forms for more than 50 years. They achieved fame after the George Soros-run Quantum fund forced the pound out of the ERM in 1992, netting Soros an esti mated $1bn and putting the Hungarian investor on the front pages. They achieved notoriety after causing the near collapse of the financial system in 1998, when the supposedly unsinkable Long-Term Capital Management fund went under.

But Fink, whose company accounts for roughly 5 per cent of the $600bn invested in hedge funds, says that the industry has changed since then. ‘As a whole it is a bit less leveraged now and a bit more diversified, so I think there is a lower chance of a major blow- up.’

Indeed, some investors have argued that hedge funds are not risky enough.

‘One of the complaints about hedge funds is that they don’t generate enough risk,’ says Iain Jenkins, editor of Hedge Fund Intelligence , an industry newslet ter. ‘People put money into hedge funds to generate exciting returns, but they are managed much more cautiously than they used to be.’ Jenkins adds that management of the funds has become more sophisticated. ‘They have far better risk- management programmes than ever before.’

Investors appear to believe the Fink mantra. According to Tass Research, investors put a record $13.83bn of net assets into hedge funds in the second quarter. This beats the previous quarterly record of $8.82bn set in the second quarter of 2001.

Meanwhile according to a recent KPMG survey, pension fund managers have become increasingly interested in alternative investments in the wake of the three-year bear market. Not surprisingly, the net asset flows into hedge funds this year have already surpassed last year’s total of $16.28bn.

However, there could be new problems for the hedge fund industry. Fink admits that the recent volatility in the equity and bond markets could cause some funds to struggle: ‘There are rumours of some problems among some major funds.’ Several funds have seen a loss of more than 10 per cent of their assets over a month in the wake of the bond market slump, and funds can be forced to close if investors demand their money back after poor performance.

While funds that focused on government bonds or mortgaged-backed securities have been hard hit, others will have benefited strongly from the corollary bounce in the equity market. ‘The largest proportion of the hedge fund universe is concentrated in the equity sector and much of it has benefited from the rise in the equity markets.’

Not all fund managers are convinced that the hedge fund universe will continue to expand. ‘Alternatives are the new mantra. They’re overblown,’ said one asset manager. ‘Hedge funds are hugely risky. They’ll come a cropper, for sure, as will bonds,’ declared another.

So far, though, the hedge fund market does not look over- supplied. There are now more than 6,000 funds managing more than $600bn – more than double the amount under control at the time of the LTCM crisis. But Man estimates that the market is still growing at more than 20 per cent a year. If too many funds were chasing too much money, management fees would start to fall. But this does not seem to be the case. ‘For individual managers there is no downward pressure,’ says Fink. Indeed, according to Jenkins some fund managers are even managing to increase their prices.

‘Most hedge fund managers charge 2 per cent flat fee plus 20 per cent of the profits, but some managers are now looking to take 30 per cent of the profits above a certain level of returns.’ What is more, they are getting it. ‘The new funds starting out might have difficulty charging high fees, but the more experienced successful managers can actually raise their fees.’

Despite their continuing growth, UK investors are still shying away from hedge funds. ‘They have a love affair with equities,’ says Fink.

Moreover, regulators at the Financial Services Authority are making it difficult to attract new investors. ‘With all the problems in the financial services industry, I don’t blame the FSA for being somewhat defensive in their regulation, but it makes it difficult to bring UK investors into hedge funds,’ Fink says.