EUROPE – Investors in hedge funds could face disappointment, according to separate reports from Watson Wyatt and UBS.

Consulting firm Watson Wyatt pointed to capacity constraints in the hedge fund market. It said in a note: “It follows that a lot of investors in hedge funds are going to be disappointed.”

And investment bank UBS said: “Expectations of future hedge fund returns could be – as possibly every other investment historically (real estate, equities, tulip bulbs, etc.) – too high, and potentially a source of disappointment.”

Watson Wyatt advised pension funds to focus on hedge fund strategies that are less constrained by capacity, such as long/short equity.

“These may be more volatile, but we believe that most clients are able to take a little more volatility in their hedge funds allocations.”

The firm added that it is expanding its research into long/short equity funds and in the fund of hedge fund field.

It estimates that just five to 10% of current hedge fund mangers are “highly skilled” – and that investing with them will become increasingly difficult. It had questions about “how much growth can be sustained going forward without manager quality declining”.

Meanwhile, UBS – in an 80-page research report called ‘ The critique of pure alpha’ - pointed out that generating alpha is “becoming more difficult over time”. And it said that there is an undeniable blurring of the line between hedge funds and traditional asset management.

It pointed out that some investors thought the 180 basis-point fall in alternative investments in the second quarter of 2004 was a catastrophe.

“If a 180-basis point loss is referred to as a catastrophe, then there is certainly room for disappointment going forward.”

Noel Amenc, director of the Edhec Risk and Asset Management Research Centre, told a briefing today that people were now moving from beta from alpha in the hedge fund universe. He called this “alternative beta”.