Funds of hedge funds are being seen as a broken model, with years of relatively low returns diminishing investors’ appetite for paying additional fees on top of that charged by traditional alternatives managers.

However, survivors of the post-financial crisis wave of consolidations say they can see a brighter future ahead.

“Post-crisis, the move towards going it alone has begun to fade,” said Ray Nolte, co-managing partner and chief investment officer of $13.4 billion AUM fund of hedge funds (FOHF) SkyBridge Capital.

The first wave saw investors allocating directly to hedge funds – or going it alone – as a way to cut costs.

Some investors are “reconsidering” their decisions to invest directly in hedge funds or through consultants that they had engaged to advise on initial direct allocations, said Mats Sjostrom, executive director of Hong Kong-based Sail Advisors, the Hong Kong-based $2.2 billion AUM fund of hedge funds specialist.

“Investors seem to conclude that rebalancing a portfolio over time is much harder than starting a portfolio anew,” observed Nolte.

However a wider range of investors have started portfolios anew in recent years, giving rise to a second wave of strains on the industry.

Eurekahedge analyst Mohammad Hassan acknowledged that the industry is stabilising, albeit “still in decline mode”.

There have been 33 more FOHF closures than launches in the first half of this year globally, according to figures from the data provider, down from a net decline of 111 in the whole of 2014 and 214 in 2013.

“Your average-performing generalist FOHF is quickly disappearing from the landscape,” said Nolte.

Sjostrom pointed out that Asian FOHFs met specialist needs. Many institutional investors who have gone the route of investing directly in US- and Europe-based hedge funds continued to access Asian hedge funds via the fund-of-funds route, explained Sjostrom.

More institutional investors have established in-house teams to make direct investments but still “look to funds of funds to fill the gap,” said UBS Hedge Fund Solutions’ global head of product specialists Jerome Raffaldini, referring to incomplete internal expertise – whether that was in specific strategies or regions.

“When it comes to ongoing monitoring of managers and portfolio rebalancing, the added value of an experienced fund of funds becomes more apparent,” observed Sjostrom.

Still, institutional investors’ rising share of hedge fund investments has placed further strain on those smaller FOHFs which lack the resources to meet stringent demands for transparency, governance and knowledge transfer.

Furthermore, the industry continues to see outflows. Asia FOHFs’ saw investor redemptions – or net outflows – of $631 million in the first half of 2015, according to Eurekahedge data. While that is down from $7 billion in 2013 and 2014 combined, the industry has continued to shrink.

Globally, net asset outflows from FOHFs amounted to a huge $19.7 billion in the first half of this year.

Some are pinning their hopes on more inflows from institutional investors, given the potential size of their allocations. “Institutional investors are very much the fastest growing category,” observed Raffaldini. “In five years’ time they will account for 90% of assets,” he predicted, referring to total hedge fund AUM.

Others are betting on strong growth from individual investors. Aberdeen Asset Management is set to add to its liquid alternative mutual fund offering with its acquisition of $11.5 billion FOHF Arden Asset Management, for example, which was announced on August 4.

Arden Asset Management had itself been a consolidator in the industry, acquiring then-$1.3 billion AUM FOHF Robeco-Sage in 2011, for example.

Raffaldini expects to see more consolidation. “We’re in the seventh innings,” he said, leaving two innings still to play.

Nolte argued that “these top FOHFs are generally getting bigger, they now have greater ability to negotiate fees and other terms with the underlying managers.” Still, bigger typically means less specialised.

Towers Watson’s latest global alternatives survey shows that Blackstone, Grosvenor Capital Management and Permal are the top FOHFs for pension funds, which account for the largest share of industry AUM.

A different set of firms – namely UBS Global Asset Management, HSBC Alternative Investments and Morgan Stanley Investment Management – are the leaders when it comes to attracting AUM from wealth managers, the second-largest allocators to FOHFs.

The post-global financial crisis trend of investing directly in hedge funds has seen FOHFs’ share of assets decline from a peak of 43% of the total in 2007 to 23% now, according to data provider HFR.