K – Former Watson Wyatt partner and senior investment consultant Stephen Oxley says pension funds should allocate between five and 10 percent to hedge funds.

Oxley advocates hedge funds, saying they are “a good source of alpha when alpha is in short supply”. He said the allocation to hedge funds could come out of equity exposure. Hedge funds are a proxy for equities, Oxley said, though they have a low correlation to stocks.

A recent report by Morgan Stanley said funds of hedge funds will account for more than one third of hedge fund assets by 2006.

Oxley, who left Watson Wyatt in September 2002, is now managing director of the new European arm of US-based fund of hedge funds firm PAAMCO. The firm’s London office has just received approval from the regulator, the Financial Services Authority.

Oxley said in an interview that he expected the new office to have up to one billion euros under management over a five-year timeframe.

The new European arm has already been on the short list for European mandates, Oxley said. The firm will focus on the UK, Germany, Scandinavia, the Netherlands and Switzerland.

He said large Dutch pension funds such as Stichting Pensionenfonds ABP, Blue Sky and Metalektro have already made hedge fund allocations.

PAAMCO would target smaller funds and larger funds that are looking at raising their allocation. PAAMCO has 2.5 billion dollars in assets under management.