U.S. retail investors have had a growing appetite for hedge funds, and now European investors will get the chance to test the waters in these high-return, sometimes risky investments, as Spain is the first European country to introduce retail investors to hedge funds, according to Boston-based consultancy firm Aite Group.

"Spain is really taking the lead in Europe in introducing hedge funds to the market," said Phillip Silitschanu, senior analyst, director of European research and author of the Aite Group recent report, "Spain's Introduction of Retail Hedge Funds: Who's Next in Europe."

"There will not be huge inflows overnight, but I think that hedge funds and hedge funds-of-funds will catch on with investors," he said.

In 2005, the "Summer Law" was passed in Spain, which introduced hedge funds-of-funds and hedge funds to the market. Spain's market regulator approved the final rules surrounding the sale and marketing of the products at the end of last year.

"Spain has long been dominated by a handful of banks that traditionally offered very conservative products that were generally managed by in-house asset managers. The floodgates are now opening in Spain, and they are starting a veritable revolution in the financial services market," the report states. Currently, nearly 70% of all assets in Spain are in fixed-income or guaranteed products, Aite Group notes.

Hedge funds-of-funds will see more growth than hedge funds at first, experts agreed. It is easier for retail investors to get into hedge funds-of-funds, plus they have lower minimums and a higher level of security, Silitschanu said.

With hedge funds-of-funds, investors don't have to worry about manager selection since there is a built-in gatekeeper, noted Ferenc Sanderson, a senior analyst at Lipper of New York. However, some experts are predicting that the account balances might be small, as there are no investment restrictions, Aite Group notes.

There are some requirements for retail investors that are quite interesting, Sanderson noted. Investors must meet two of the following requirements to invest in hedge funds: they must have a minimum investment of 50,000 Euro, roughly $68,000; be registered for professional investor status; or have completed 10 security transactions in each of the previous four quarters.

However, some experts wonder if hedge funds will catch on with historically conservative Spanish investors. The question is whether Spanish investors are conservative by nature or because the government has made the market conservative, Silitschanu said.

Silitschanu believes that hedge funds will become popular. From a macro point of view, Spain has a younger demographic compared to other European countries. They are more interested in finance, have an appetite for risk and are looking to grow their money, he noted.

Nearly 30 asset managers have already received authorization to manage hedge funds in Spain, the report states. Well-recognized hedge fund Optimal Investment Services is building its shop in Spain and anticipates having $10.2 billion assets under management in hedge funds-of-funds by the end of this year.

Over the past few years there has been a huge influx of new hedge funds to the U.S. market, and many portfolio managers have jumped ship from mutual fund companies to launch hedge funds. Most likely that will not happen in Spain, experts agreed.

The market in the U.S. is very advanced, Silitschanu said. Managers have experience with cutting-edge investment products more so than Europeans. The majority of asset managers in Europe have worked with fixed income and guaranteed products and do not have enough expertise to make the switch, he said.

There is trend of hedge funds being offered to retail investors in Europe, but it depends on the particular region, local and legal restrictions, Sanderson said. There is no uniformity in regard to what will take place the next few years in terms of hedge fund products for retail investors, he said.

Experts believe the U.K. might be the next European country to introduce hedge funds to retail investors, while Silitschanu said U.K. asset managers might domicile them in Spain. And as much as German regulators have lashed out against hedge funds, they will most likely allow them at some point, as they won't want to be the only country in Europe without them, Silitschanu noted.

The U.S. market will be affected by this as well, as there will be a relatively significant hedge fund market outside of the U.S., Silitschanu said. It will put a bigger squeeze on hedge funds in the U.S. to have successful strategies, he explained.

This does not mean that long-only managers should scramble to develop or buy hedge fund management teams yet, the report states. There will certainly be a notable increase in retail flows, but the most important point to bear in mind is that retail can be a very vague term as investment minimums vary widely among hedge funds, according to Aite.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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