UK – The incoming chairman of the National Association of Pension Funds’ investment council, Chris Hitchen, says the hedge fund industry is “inherently unstable”.

“However, we must also bear in mind that the hedge fund industry is inherently unstable, because it uses leverage and seeks to generate long-run returns with short-term horizons (at the expense of other marketplace players),” Hitchen said in an article, writing in his capacity as managing director of Railpen Investments.

“Moreover, it does not, in general, seek to exploit any theoretical source of economic return. Unlike equities or bonds, hedge fund returns should primarily be derived from pure skill.

“This may be the greatest limited factor in determining the eventual size of the hedge fund industry,” Hitchen said in an article in the latest issue of PricewaterhouseCoopers’ ‘Investment Management Perspectives’.

“In summary, we are inclined to use hedge funds as an asset in a moderate but meaningful way as a diversifying, moderate return asset, which has acceptably low and appealing risk by comparison with other assets,” Hitchen said.

“There is an element of truth in what he’s saying, but hedge funds are many different things,” said John Godden, managing director of Hedge Fund Research. “There are at least 37 different methods employed across the whole gamut of asset classes.” Godden said it was this diversification which created stability.

“There seems to be a real polarisation of views in the UK pension fund industry. There is a slight head-in-the-sand aspect to it.” Godden saw “wave upon wave” of new manager skill emerging from investment banks’ proprietary trading desks over time.

The comments come as a new report from Greenwich Associates found that hedge fund use by US pension funds and other institutions was on a “steep upward curve” in 2003. Greenwich said that 23% of funds reported hedge fund use – up from 12% in 2000.

“The dramatic influx of pension assets into hedge funds is beginning to have profound effects on the asset class. Given the determination of plan sponsors to raise their returns, however, it seems probable that they will overcome any developing concerns,” Greenwich said.

And it added that corporate and public pension funds report
a five percent average target allocation for hedge funds.

Hitchen formally takes over the chairmanship of the NAPF’s investment council from Ken Ayers at the association’s annual conference in May.