An air of optimism pervades among hedge fund professionals as they expect pension funds to increase their exposure to hedge fund strategies over the next five years. A new global survey commissioned by State Street among 235 hedge fund professionals show 63% believe institutional investors will also be increasing their exposure to hedge funds in the next five years.

Of the 55% of hedge fund professionals who expect pension funds to increase their allocation, 53% believe the main driver of this is the performance challenges facing investors' portfolios while 35% think it will be a growing focus on portfolio diversification and 13% note it will be improved terms offered by hedge funds.

However, to really capitalize on the growing appetite for hedge fund strategies, nine out of 10 industry professionals interviewed believe hedge funds will be required to more clearly demonstrate their value to prospective investors.

Maria Cantillon, global head alternative investment solutions sales at State Street said, "Despite the challenges facing the hedge fund industry, our findings show that many working in the sector are optimistic about its future prospects. This is being fuelled by challenges facing asset owners as they search for better returns and greater diversification. The hedge fund industry is maturing and becoming more transparent and competitive.

In terms of how hedge fund professionals see their own firms changing over the next five years, 60% expect to broaden the range of investment strategies they manage; 37%anticipate that they will expand abroad and one in 10 expects to acquire another company.

According to the survey, regulation will continue to have a significant impact on hedge fund managers. However, the full impact of Basel III is yet to be determined, with 29% of respondents believing that it will significantly increase their firm's cost of financing, compared to 42% saying it wouldn't and the remainder (29%) saying they don't know. The findings also suggest growing competition from alternative mutual funds. Half of those interviewed believe that over the next five years, they will seize market share from traditional hedge fund strategies.