GLOBAL – Roger Urwin, global head of investment consulting at Watson Wyatt, says the performance of fund of hedge funds is “in doubt” due to a lack of capacity at some of the managers.

“Fund of hedge funds have provided a useful addition to a number of our clients’ portfolios, giving them not only diversification and the prospect of added alpha, but also flexibility in risk management,” Urwin said.

“However, the capacity of some of the managers of these strategies to continue to deliver good performance is in doubt given the size of new money flows occurring.” The comments accompanied a survey of alternatives conducted by the firm.

There is currently a debate about the effect of manager capacity on hedge fund performance. Earlier this month, French business school Edhec said there was “absolutely no proof of a ‘capacity effect’ in the hedge fund industry”.

Watson said pension funds globally invested more than $62bn in alternative asset classes during 2004. That broke down to almost $30bn in property, $17bn in private equity and $16bn in fund of hedge funds.

Forty-nine percent of schemes’ alternative assets are real estate, while 38% is in private equity. Thirteen percent is in fund of hedge funds.

Urwin said: “Pension funds continue to reduce their reliance on equities as they find suitable alternative sources of risk. The message of diversification is definitely getting through.”

Fund of hedge funds accounted for around half of all new money invested in alternatives last year – or $81bn, up from $41bn the year before.

Watson also noted that commodities rose 52% to $5.6bn. Urwin said: “Although commodities is not major asset class, interest from institutions, especially mutual funds, is steadily increasing.”