The case for investment in hedge funds remains intact despite the industry facing possibly the heaviest redemptions in a decade in the second quarter of this year, major investors in the funds said yesterday.

Hedge fund performance in April was the worst since the emerging market crisis in 1998 after many were caught in loss-making positions in the fall-out of the ratings downgrade of General Motors and Ford Motor debt.

This raised the spectre of severe difficulties in the $1 trillion (€800 billion) industry rippling out across the global financial system as the funds account for huge volumes of trades in equity and debt markets and are big earners for major investment banks.

But analysts said the damage inflicted by events at the US auto giants should be contained and the volatility this has injected into financial markets is again creating the conditions in which hedge funds thrive.

"The hedge fund industry has lower leverage than before. Some managers don't know how to handle rising interest rates, but in general it is not a bleak outlook," Klaus Martini, global chief investment officer for private wealth management at Deutsche Bank told a conference.

"If nothing really goes wrong and we only see a few blow-ups the industry should see returns of up to 4 per cent to 5 per cent [ in 2005]. For funds of funds we see returns at 2 per cent to 4 per cent plus above the risk-free [government bonds] rate." He was speaking at the Euromoney Private Wealth Management Forum. "Most people don't sit on the fence for hedge funds - they're either wonder products or a disastrous bubble... (but) between 1994 and 2004 hedge funds have produced significantly higher returns than global equities at half the risk," Richard Turnill, chief investment officer at Merrill Lynch Investment Managers Global Private Client (GPC) group said.

Turnill said hedge funds are not an asset class, but a product in which investors can choose more risk adverse and stable low return strategies or take on riskier bets.

He added it wasn't a surprise that riskier hedge fund strategies, such as convertible arbitrage or long/short equities (which are mainly long stocks) trades had lost money recently.

In convertible arbitrage strategies hedge funds trade the different components - equity, bond and derivatives - of convertible bonds which can be converted into a company's stock.

"When you have periods like the last two weeks with widening credit spreads and a sell-off in the equity markets you have downside risk. I'm very positive hedge funds will continue to produce returns well above cash and continue to diversify portfolios," Turnill said.

He said hedge funds were going through a painful period because the predominant "carry trades" were coming to an end as the US Federal Reserve raised interest rates.

Many hedge funds strategies are based on carry trades, borrowing money at the short end of the interest rate curve and placing it at the long end, and so are vulnerable to an upturn in the interest rate cycle.

"As volatility rises and credit spreads widen, opportunities for hedge funds start to appear again going forward and that's the time to think about getting back in," Turnill said.

MAN Group, the London-listed hedge fund company, yesterday reported a robust performance for 2004 in spite of the recent difficulties for the sector, with pretax profits up 9.6 per cent at $784 million.

But with the lower returns achieved in the past 12 months, net performance fee income was down 50 per cent to $119 million. Stanley Fink, chief executive, said the group was confident of its prospects for this year, although one of the group's largest funds, the trend-following AHL diversified futures fund, is reportedly down 5 per cent so far.

In a tough environment for hedge funds, Man said its flagship AHL fund had fallen 1.2 per cent over 2004 and figures from the company showed that only three out of 11 funds ended the year in positive territory.

But investors were relieved that the results were not worse and the group's shares, which lost more than 20 per cent of their value last year, jumped 5.6 per cent to £12.92 (€18.80) in morning trading.

The group saw total fund sales of $12.1 billion in the year, including $5.8 billion of institutional sales, said Fink, and had continued to bring in new money in the current year with $438 million raised in its latest global launch.- (Reuters)