Boutique-founder Charles Montanaro has told Citywire he thinks there is to be a major shift in asset allocation as investors prepare for the next bull market, with the long-only manager poised to benefit from the demise of the hedge fund.

He draws comparisons between the problems faced today with the problems caused by junk bonds in 1990, a time when Montanaro was working at Drexel Burnham- a firm which was at the forefront of the controversy.

'Winding the clock forward 18 years, the finger of blame for the disarray in financial markets is not the junk bond trader it is the equity hedge fund manager,' he says. 

'It may be that we may be about to witness a fundamental shift in asset allocation,' he says. 'It will be far harder for hedge funds to generate “alpha” where their hands are tied: banks are already less keen to provide the essential leverage; stock lending has become far more expensive and less readily available as institutions face up to considerable counter party risk and there are fewer prime brokers these days; and short-selling has been banned in the US and restricted in the UK.' 

The A-rated manager of the Montanaro European Smaller Companies fund thinks hedge fund managers can expect even more bad news to come.

'On the basis that the Americans tend to overreact to crises – witness Sarbanes Oxley [legislation introduced in wake of the Enron scandal] – it would be unsurprising for the US regulators to introduce punitive disclosure requirements.  There may well be restrictions on leverage as well.' 

'Consultants have been criticised for encouraging hedge funds, many of which have failed to provide capital preservation despite exorbitant fees,' Montanaro says. 'After nearly a 50% decline, the logic for hedge funds is less compelling than at market tops. Maybe we will see a return to traditional long-only equity investing as we prepare for the next bull market. Small caps would do particularly well.'

Looking at the events in stockmarkets last week, Montanaro believes financials may have hit their bottom but that does not mean the outlook is suddenly rosy.