GLOBAL – The Bank for International Settlements, the central banks’ central bank, says fund managers’ claims about the diversification benefits of hedge funds may be overstated.

The BIS said the “remarkable similarity in the performance of funds with purportedly distinct investment strategies implies that, in practice, the diversification benefits to the investor might be considerably smaller than fund managers claim”.

And it said that weaker hedge fund performance was in part responsible for the “marked slowdown” in inflows to the sector during more recent months. The comments came in the bank’s annual report.

It also entered the debate about hedge fund capacity. It said that a side-effect of the sector’s growth has been the “disappearance of exploitable investment opportunities” in the traditional areas of hedge fund activity, such as equity and government bond markets.

This has led managers into areas such as corporate bonds, credit derivatives and structured finance – which has aided overall liquidity.

The BIS said that better counterparty risk management practices are in place compared to the situation around the near collapse of Long Term Credit Management in 1998.

But it said: “However, given the rapid growth in assets under management and the intensifying competition for prime broking business, the overall exposure of banks to the sector is arguably higher and the information flow less transparent.”

The bank also looked at the low level of long-term interest rates. It said: “Many market participants cited prospective pension fund and accounting reforms as fuelling demand for long-dated paper.” But it said it was difficult to quantify the impact of factors such as pension fund buying and the accumulation of US dollar assets by Asian authorities on low rates.

Meanwhile, the report also looked at the BIS’s own pension scheme. It said the return on fund assets in 2005 was 3.2%, against 13.9% in 2004.