The future will (not 'may') hold many surprises, and some could make a huge difference to our world view.  However, here are our thoughts on how the hedge fund world may pan out over the next 2-3 years.

In summary, the hedge fund world will (i) see higher returns (ii) see strong new manager formation (iii) be dominated by small boutique managers (iv) have relatively few very large funds.

Returns will be higher, possibly much higher, than they were 2006-2008

Of (very roughly, erring on the conservative side) US$2tn of hedge fund assets, and >US$4tn of investment bank trading assets, at the beginning of this year, we will, by the beginning of 2009, have lost perhaps 1/3 of the hedge fund assets and 3/4 of the world's banks' prop trading assets.  Assuming (and this is perforce guesswork) that aggregate leverage in the hedge fund ecosystem falls from 3x to 1.5x, and that ditto in the prop desks drops from 20x to 10x, that means that US$86tn of alpha-seeking capital will become US$12tn, an almost 90% implosion.  This is conservative. At a recent conference, we heard Paul Marshall, of Marshall Wace, estimate that half of all hedge fund capital, and 80% of investment bank trading capital, would evaporate.

(Goldman Sachs' reduced their overall leverage from 24x to 16x, still, to our mind, an extraordinary number. We're assuming that the majority of the new owners of investment banks will not be as confident of their new-found treasure's ability to manage risk and will run significantly lower leverage. Professional trading units outside banking, such as Cargill, typically run at around 10x and we feel this is a realistic estimate.)

This accords with our view of the number of stocks in Asia with institutional levels of liquidity.  (From a Singapore base, we naturally see more data points from Asia than the 'developed' markets.) In the summer of 2007, this was perhaps 500.  Now, it's more like 50, across the whole region.  In brief, alpha-seeking capital has shrunk by an order of magnitude.  As liquidity across the financial system continues to ebb, we believe that we may still not be at the low point.

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