breakingviews in the Wall Street Journal wonders if the supply of hedge funds is outstripping demand? As investors clamored to get into hedge funds, the top managers were able to raise both their management fees and their incentive fees to levels once thought to be usurious.

With the bloom seemingly off the hedge fund rose as inflows slowed in 2005. This may return some balance to the investor/manager relationship.

Hedge-fund supply may shortly exceed investors’ demand, returning the balance of power to investors. Institutions should use their muscle to push down fees. They must also find ways to prevent funds from receiving performance fees for returns which have been generated by rising markets, rather than superior investment skills. Without these changes, hedge funds will fail to satisfy investor requirements and the recent boom in hedge funds will, as Warren Buffett predicted, turn out to be merely a fad.

Riva D. Atlas in the New York Times notes another trend reversal in the hedge fund industry. As hedge fund returns have stagnated, a number of high-profile, investment professionals who abandoned the mutual fund world for hedge funds are returning to their more staid roots.

“It used to be a one-way street, with all the traffic going to the hedge funds,” said Jeff Garrity, a managing director at Russell Reynolds, the recruiting firm. “Now, for the first time in years, we are starting to see movement in both directions.”

Managers have been enticed back to the world of mutual funds in part to changes in the way some mutual funds are now managed. Increased flexibility in their investment strategies has closed the gap between what a mutual fund and hedge fund can do. The rise in these so-called ‘hybrid funds‘ is a trend that has attracted a fair amount of media attention.

2005 was indeed the year of the hedge fund. However the seeming hedge fund trend seems to be slowing. It will be interesting to see how it plays out in the new year.

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