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From Martin Gagnon, Managing Director - Alternative Investments, National Bank of Canada

The year 2004 will most likely turn out to be the third worst on record for hedge fund returns. The majority of Funds of Hedge Funds should post returns below their stated targets of Libor plus something. As usual, there is a lot of disparity between styles and with only 2 categories returning double-digit figures (CSFB event – distress +13.43% as of November with the second best being CSFB emerging at +10.94%) many questions are being asked. At the same time, we have witnessed continued growth of assets under management, with Tass asset flow reporting an increase of 25% since Dec. 2003. This growth in assets under management was driven by the increased participation of the institutional world, and especially, pension funds. Because of these facts, most of the questioning is centered on the relationship between poor returns and the increased size of the industry. Is this industry a victim of its own success? Have we collectively eroded alpha? What are the lessons we learned in 2004?

…Given this difficult environment, hedge fund investors, and particularly Funds of Hedge Funds, have taken action. Since it is estimated that Funds of Hedge Funds now control approximately 40-50% of the assets that are ultimately funnelled to single strategy managers, market participants watch their actions very closely. In general, we have witnessed two types of reactions by the Funds of Hedge Funds c......................

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