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LONDON (Reuters) - The hedge fund industry has become "contaminated" by being too correlated to equity markets and could deliver negative returns this year, according to high-profile hedge fund manager Hugh Hendry.
Speaking at the Reuters Hedge Fund & Private Equity Summit in London, Hendry, who is chief investment officer and partner at Eclectica Asset Management, said the hedge fund industry had been in a bubble in recent years and was set to see lower returns from speculation.
His comments call into question the role of hedge funds, which are meant to be able to make money in all conditions but which have suffered this year as volatility has risen and market returns have plunged.
"The returns on conventional speculation I think have peaked," said Hendry. "There are too many stockbrokers, there are too many hedge fund managers ... Returns will diminish. It's happening."
"We have had a bubble in alternative banking, a la hedge funds and everything else ... One guy making $1 billion (500 million pounds) -- this is a cathedral that comes at the end."
After returns of 12.56 percent in 2007 and 13.86 percent in 2006 according to Credit Suisse/Tremont, the $2.5 trillion hedge fund industry has been hit by volatile markets, investor redemptions and prime brokers paring back leverage.
According to preliminary data from the BarclayHedge Fund Index, the average hedge fund lost 4.4 percent in the first quarter, while other firms measuring hedge fund performance also show falls.
"In 1999-2000 the world had very little committed to hedge fund strategies and hedge fund strategies were ideal for the period 2000, 2001, 2002. The world therefore fell over itself in presenting money to hedge funds," Hendry said.
However, he said hedge funds had become too focused on achieving -- and hence too correlated to -- equity market returns, which have been hit by the onset of the credit crisis last summer.
"Suddenly hedge funds changed the parameters of how they viewed risk. Risk suddenly became underperforming the index, underperforming long-only (funds), and you could argue that history would suggest that hedge funds have morphed into institutions and into long-only.
"History would suggest a contamination of the spirit of hedge funds, such that they lose what was unique about them seven or eight years ago, and therefore as we get a downturn once more they disappoint expectations and they begin to show a sensitivity and a correlation with markets when one wasn't expected."
On Tuesday Centaurus Capital chairman and chief executive officer Bernard Oppetit told the Reuters Hedge Fund & Private Equity Summit that it was unrealistic for hedge fund investors to expect double digit returns every year.
Hendry also said that the growth in shareholder activism by some hedge funds could be a reflection of the institutionalisation of the hedge fund industry.
"(This) would explain why you get this activist role. If you're so big that actually you can't sell your stock it makes sense more to park your tanks on their lawn and argue for activist change," said Hendry.
"That's kind of a function that the outsiders have become insiders and are debating with the chief executives to change the business."