While one of the big trends in the mutual fund industry has been its embracement of sophisticated alternative investments, mutual funds and hedge funds are both about to become even more complex in the next year, the Financial Times reports.

In Europe, Asia, Africa and Latin America, funds are taking advantage of the European Union’s 2006 Ucits III legislation, which permitted regulated funds to increase their exposure to derivatives and other asset classes.

“This is going to completely change the investment industry as we know it,” said Michael Ward, chairman of the Ucits III steering committee at Merrill Lynch. He said that long/short 130/30 funds are only the beginning.

“We are being approached by a number of hedge fund managers asking us if it is technically possible to do convertible arbitrage in a Ucits environment,” Wards said. “I’m certain that there is going to be a broader range of strategies to choose from.”

Guy Monson, chief investment officer at Sarasin Chiswell, which recently launched a suite of mutual funds that employ hedge fund strategies and raised $625 million, said, “It’s a big bang, and we have only just scratched the surface of what we are going to see in the next two or three years. It’s hard to underestimate what a revolution this is. You ain’t seen nothing yet.”

In the U.S., Merrill Lynch estimates that $75 billion is currently invested in mutual funds that use alternative strategies, with two-thirds of that money in 130/30 funds and the rest in market-neutral funds. Steve Deutsch, an analyst with Morningstar, said three of the drivers of the interest in such funds is investors’ increasing familiarity with hedge funds, lower returns in long-only funds and mutual fund companies’ interest in going head-to-head against hedge funds.

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