GERMANY- The German hedge fund markets, newly open to institutional investors, could grow to 20 billion euros in the next five years, according to consultant Mercer.

Germany allowed hedge fund investments in January, permitting single manager hedge funds to be sold to investors and funds of hedge funds to be sold to a broader investor base.

But institutional clients still tend to see hedge funds as risky and “too aggressive”, and are unaware of the different risk profiles offered by the asset class, Herwig Kinzler, head of the investment consulting practice in Germany, said.

Less than five percent of institutional investors have so far allocated resources to the asset class, and the allocation has been under two per cent of the portfolio.

Kinzler argued that things may change when financial regulator Bafin issues rules on how pension funds and insurance companies can invest in hedge funds by the autumn.

“This is a major step in granting the opportunity in diversifying German institutional investors portfolio, even if the initial investment limits are restrictive,” he said in a report.

“We believe that this development might add importance to the debate and accelerate allocation to hedge funds.”

Investment in hedge funds are likely to be limited to five percent of the portfolio, but Kinzler said that if the asset class got between one and two percent of asset allocation and the current assets’ volume of a trillion euros grew by 30% in five years, the hedge fund industry would be worth 20 billion euros in 2009.

“Investors must use a rigorous due diligence process and managers selection process,” he said, adding that institutional investors would be allowed to outsource risk management.

Kinzler also emphasised that German investors had not been completely barred from the asset class but had to invest abroad and that “structured notes” were also necessary to embark on the investment.

The “very detailed” rules and transparency requirements for tax and regulatory purposes may prompt off-shore hedge funds and funds of funds to continue to use structured notes to deliver their products in the German market, adding to the costs of investments in hedge funds.