The $1 trillion hedge fund industry is poised for a period of consolidation and slowed growth over the next three years as waning performance and large inflows will drive down fees, accounting firm KPMG and U.K. think tank Create said on Monday, Forbes.com reports.

Merger and acquisition activity will heat up among hedge funds within the next three years, the study showed, causing the industry to shrink. In addition, poor-performing hedge funds will be forced to shut down their operations.

In some nations, like Germany for example, hedge funds have come under intense scrutiny from politicians for their activities. In the U.S., the impending registration of hedge funds will impose stricter regulation of the investment vehicles not seen before in their history.

The report said a major cash infusion from pension funds will force hedge funds to introduce greater transparency and adopt different governance structures, transforming hedge fund management from a craft to an industry. Hedge funds will also face greater competitive pressure from mainstream funds, many of which are copying hedge funds in pursuing absolute returns, and are offering similar investment products. 
The authors of the report said these two emerging trends are likely to result in average returns over the next three years being "far lower" than the hedge fund industry's own expectations, according to Forbes.com. A survey of global hedge fund managers revealed that over half expect average returns of 11% to 20% between now and 2008, unchanged from the last three years.
KPMG and Create add that investor interest in hedge funds will diminish as equity prices continue to recover from the three-year stock market downturn. The authors estimate that there are now some 8,000 hedge funds, Forbes.com said.

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