The European Union’s first real attempt at regulating the region’s alternative investment industry is likely to advance the convergence of hedge fund and long-only investment strategies—potentially ushering in a period of consolidation and the blurring of the lines between the two.

With the Alternative Investment Fund Managers Directive (AIFMD) due to be transposed into national law by July 2013 across the 27-member European bloc, a recent industry-wide survey has revealed that more than two-thirds of respondents, with combined assets under administration exceeding $16 trillion, believe that the AIFMD will be the catalyst for the coming together of long-only investors and hedge funds.

The survey, which received more than 50 responses from senior participants across the global fund administration industry, was carried out by Multifonds, a software provider to the investment funds industry, in June.

“The convergence of long-only and alternative investing is happening and likely to continue,” Mark Parsonson, executive director of U.K.-based fund of hedge funds manager Liongate Capital Management, which has $3bn under management, told Markets Media.

“Long-only investment houses are adapting, driving convergence not just from hedge funds towards long-only but from long-only towards hedge funds. The crisis of 2008 has led to a lot of change within the asset management industry and much of this has been driven internally through evolution of investment practice.”

Parsonson believes that apart from the upcoming AIFMD rules, another earlier influence towards this convergence was the European Union’s Ucits III directive in 2001, which allowed hedge funds to market to retail investors. This allowed some hedge fund managers to launch versions of their strategies in a Ucits version, which significantly enlarged the range of investment instruments that could be used, so more investors could access them. Ucits are retail open-ended investment funds that comply with the 2001 European directive and are distributed throughout the region.

“I would argue that the implementation of Ucits III has been the main driver of convergence,” said Parsonson. “Greater breadth of investment opportunities and risk management policies have allowed many hedge fund strategies to convert to Ucits III structures and gain broader distribution and access. This trend is well established and continuing.

“The lack of private capital inflows into the industry has led many hedge funds to look to Ucits III vehicles to regain access to this segment of the investment market. If the AIFMD is successful in providing a regulated alternative to Ucits III, then private investors could reassess the attractiveness of traditional hedge fund vehicles. This may actually lead to a slowdown in the convergence of long-only and hedge funds.”

Parsonson added: “Ultimately, ‘convergence’ needs to be put into context. A large part of hedge fund strategy returns are generated through their ability to exploit opportunities that traditional investment strategies cannot. Often, many of these benefits are reduced when trying to implement a more constrained and regulated version of an offshore hedge fund strategy. Investors need to be aware of the trade-offs they are seeing in ‘convergence’ products. Greater liquidity and regulation are better for investor protection, but these can also lead to lower return expectations or higher volatility.”

The Multifonds survey also found that a fifth of respondents were behind schedule on the AIFMD and would not be ready to meet the July 2013 implementation deadline.

Industry respondents also thought that the controversial depositary liability reforms—where alternative investment managers will have to appoint a depository for each fund they manage who will be entrusted with safekeeping and overseeing compliance if they want to ‘passport’ the fund across EU member states—would be the most challenging element of the AIFMD, followed by operational requirements and risk and liquidity management.

“It is widely recognized that institutional investors, such as pension funds, are increasing their hedge fund allocations to diversify their asset class exposure, reduce the impact of market volatility and potentially boost returns,” said Keith Hale, Multifonds’ executive vice-president for client and business development.

“They expect higher risk management, transparency and liquidity resulting in alternative fund products that have more traditional, long-only fund characteristics. Similarly retail orientated absolute return funds, such as alternative Ucits, are driving traditional funds to incorporate hedge fund characteristics such as performance fees. These drivers aligned with the AFIMD will accelerate the convergence between long-only and hedge funds.

“This convergence poses both opportunities and challenges for the fund administrators. Those who can bring together the efficiencies of traditional fund processing with the complexities of alternative structures stand to gain market share, whereas those retaining a silo mentality and operating model, or those purely focussed on either traditional or alternatives, will be challenged in the medium term. As a result, the fund administration industry is already experiencing consolidation of long-only and hedge fund administrators, blurring the former distinction between the two types of service provider.”

Another recent survey by financial consultant Deloitte, which surveyed U.K.-based hedge fund, private equity and real estate managers this summer that collectively manage over £175 billion in assets, found that almost three-quarters of managers were likely to view the AIFMD as a business threat. This, the survey found, would likely see a reduction of non-EU managers operating in the EU with smaller managers the most concerned about the new regulation. Those fund managers that regard the AIFMD as an opportunity, however, tended to be large—managing at least $1 billion of assets—and have an existing focus on onshore, regulated funds.

The AIFMD is the first attempt by Brussels to oversee hedge funds and private equity by harmonizing regulatory standards across the EU. When it was first mooted back in 2009, the directive was heavily criticized for its potential to stifle Europe’s fund management industry. But, after endless arguments and negotiations, there is now little more than a year to implementation date and industry opinion has now turned to muted acceptance and a desire to work with authorities to make the best out of the situation.