Hedge funds will pass the $3 trillion mark by the end of this year, according to Deutsche Bank’s 2014 Alternative Investment Survey, which covers more than entities with a combined $1.8 trillion assets under management, more than two-thirds of the entire industry. The survey found that hedge funds ended 2013 with $2.6 trillion global AUM and forecasts $171 billion in net inflows alongside $191 billion in performance gains in 2014, representing returns around 7.3%

Hedge Funds

“Hedge funds continue to establish their growing position within the broader asset management industry, alongside some of the more mainstream asset managers. The hedge fund industry is predicted to reach a record $3 trillion by 2014 year end driven by significant inflows, most notably from institutional investors,” said Deutsche Bank co-head of global prime finance Barry Bausano.

Institutional investors getting more involved with hedge funds

Nearly half of all institutional investors increased allocations to hedge funds last year, and more than half expect to increase allocations in 2014. At this point, two-thirds of hedge fund AUM comes from institutional investors compared to just half that before the crisis. Considering 79% of institutional investors were happy with sub-10% returns from hedge funds last year, it may be that the crisis taught them the value of having uncorrelated returns, even if they are lower during a bull market.

The survey found that 39% of respondents now allocate assets to diversify underlying risk instead of following traditional portfolio techniques, up from 25% a year ago, and 41% of pension consultants recommend a risk-based approach to clients.

“With the majority of investors happy with hedge fund performance, we expect institutional investors to further strengthen their commitment to hedge funds,” said Anita Nemes, global head of Deutsche Bank’s Hedge Fund Capital Group. “Last year’s respondents targeted 9.2% for their hedge fund portfolios, and hedge funds delivered… Looking forward, respondents are targeting 9.4% for 2014.”

Fees coming down, but not investors’ prime concern

Investors paid an average 1.7% management fee and 18.2% performance fee last year, down from the traditional 2 & 20 model, but nearly half the respondents told Deutsche Bank that they would pay more than the typical 2 & 20 if it meant working with a fund manager with a long history of “consistent strong performance in absolute terms.”

But as the hedge fund industry continues to grow, the competition both for attractive, high-alpha investment opportunities and for clients will only become more intense, so the pressure on fees is unlikely to let up anytime soon.