Despite another muted year for hedge funds, the industry is expected to attract yet more assets with institutional investors pushing these increases as they seek higher rates of return.

Hedge funds faced a challenging year in 2012 with lower than average returns, fewer new launches, a number of larger funds closing down and a more difficult capital raising environment.

But despite all of this, the total size of the industry stood at a record $2.2 trillion as of the end of third quarter of 2012, according to the latest figures from Chicago-based data and analysis provider Hedge Fund Research (HFR), which beat the previous mark set in the first quarter of the year.

Eurekahedge, another hedge fund data provider, found that the industry grew its assets by over $75 billion last year although the formation of funds slowed in 2012 with just 959 new hedge funds launching, while fund closure rate was the highest since the financial crisis with 860 funds closing down during 2012.

The hedge fund industry was saved from further blushes by a strong finish to the year as it beat leading benchmarks for the final two months of 2012, which hauled total gains up to 6.2% for the year, according to HFR. The benchmark S&P 500 index rose nearly 14% in the same 12-month period.

“Two months of outperformance signal a welcome shift from the dominant trend of the past 12 months, when the industry gained 6.2% while the S&P 500 rose 13.6%,” said Sol Waksman, founder and president of BarclayHedge, a hedge fund data vendor.

But institutional investors are continuing to pile into the hedge fund space in the elusive search for alpha as they increasingly embrace the risk management and diversification that hedge funds offer. Hedge funds, too, are also developing new products that are competing with traditional, long-only asset managers.

Last year, it was predicted that global assets in the hedge fund industry could more than double to over $5 trillion by 2016 due to this new wave of institutional allocations, according to research carried out by Citigroup’s Prime Finance division.

Also, regulation in the U.S., in the form of the Jobs Act, is set to—intentionally or not—loosen the regulatory requirements on hedge funds.

“The hedge fund industry will set a new record for assets in 2013 despite the lackluster investment performance for the industry over the past two years,” said Don Steinbrugge, managing member of Agecroft Partners, an alternative investment consultancy.

“This will be driven by pension funds increasing their asset allocations to hedge funds, and a broadening of the hedge fund investor base due to the passage of the Jobs Act.”

Although 2013 could, in fact, turn out to be the year of compliance for hedge funds, with legislation such as Form PF in the U.S. and the Alternative Investment Fund Managers Directive in the European Union set to significantly ramp up costs for hedge funds.

“Regulators are starting to add new regulations that directly affect alternative investments,” said Harry Stahl, a partner at trading technology firm SunGard’s global services unit, in a recent blog.

“This scrutiny is becoming more and more uncomfortable for hedge funds, and many are playing a game of compliance catch-up.”