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Despite the longer nights and cooler days of fall, the forecast for merger and acquisition activity in the hedge fund space continues to be very much spring-like (Ed: See “Part 1″ here).

According to a recent report by Freeman & Co., deals involving alternative manager are set to outpace traditional manager deals for the first time this year. Through the first half of 2010, alternative asset manager deals were up 108% to 52 transactions year-to-date compared to 25 transactions in the same period last year, with the pace on track to exceed 100 before year end. (Click here for the press release, which also includes details of how to request the full copy of the survey).

The report follows AllAboutAlpha.com’s recent coverage of New York investment firm Jefferies’ take on the resurgence of M&A activity, which showed that the dark and gloomy days of “hunkering down” appear to be over.

But beyond the reality of much-reduced asset prices and the perception of much-improved economics, there are reasons for the M&A surge, in particular a guy by the name of Paul Volcker and his new “rule,” as well as other international regulatory initiatives.

Indeed, in contrast to 2007, when investment banks for falling over each other to scoop up hedge fund and fund of hedge fund firms and amalgamating those businesses with their internal proprietary trading operations, the new rule, though still vague on interpretation, is spurring the opposite movement, where large firms like Bank of America (NYSE:BAC), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS) and JPMorgan (NYSE:JPM), among others, are looking to offload their alternatives operations to the highest bidder.

The rule limits bank holding companies (BHCs) from engaging in both proprietary trading, with minor exceptions, and the sponsoring of or investing in hedge / private equity funds, with even fewer exceptions. Specifically, the rule limits BHCs investments in HF / PE to 3% of the fund’s assets or 3% of the BHC’s Tier 1 Capital. The chart below from Freeman illustrates some of the big banks’ holdings of alternatives that clearly exceed the new requirements.

There are other reasons flowers continue to bloom on the alternatives M&A front, according to Freeman, in particular expectations that businesses will (hopefully) survive and thrive in the post-2008 environment and that now is the time to invest – or on the hedge fund side, to sell.

On the fund of hedge fund (FoHF) side it’s a bit of a different tune, with activity stalled thanks to mismatched valuation expectations, lack of financing in the M&A market and what Freeman describes as “unique firm culture management issues,” the exceptions being the merger of Gartmore and Hermes’ PEFOF groups ($6.2 billion) and Crestline’s acquisition of Northwater Capital Management ($2.2 billion).

Of particular note in Freeman’s report is a trend away from FoHFs and toward direct investment in hedge funds. Direct investment in hedge funds reached $1.09 billion at the end of June, a level not seen since in 2007. However, “asset flows for hedge funds and funds of hedge funds have taken divergent paths post-crisis” as indirect investment into hedge funds has fallen.

Freeman said total FoHF assets under management is down 29% since 2007 is “driven by large withdrawals from high net worth clients, especially European, and the unwinding of all FoHF structured products, which accounted for $50 billion to $100 billion of assets under management.”

Meanwhile, Freeman’s analysis found that while direct levels of investment into hedge funds has soared to record highs, the bulk of the investment is going to the biggest and smallest managers, with the middle-sized ones being left high and dry.

In the last 12 months, hedge funds that already had at least $5 billion under management grew by just over 5%, while hedge funds that were new or had less than $500 million last June blossomed by almost 19%. By contrast, hedge funds that had between $500 million and $1 billion last June shrank by 0.3% over the year, while those that had between $1 billion and $5 billion shriveled by 1.1%.

So springtime for M&A continues into the fall, according to the latest research. Of course one never knows when a cold front is going to blow through and flash-freeze everything.

Here’s a summary of some of the report’s key findings:

Deal Activity / M&A: The number of transactions increased to 106 in 1H 2010 versus 87 in 1H 2009, a 22% increase. Total AUM involved was $417 billion. Average deal AUM size dropped from $36.9 to $5.5 billion. Deals with alternative asset managers increased to 52 in 1H 2010 from 25 in 1H 2009, a 108% increase, as the need for size, scale and distribution continue to drive M&A.

Alternatives: M&A activity in the alternative sector is on pace to exceed 2008 and 2009 levels as firms consolidate, get acquired by larger strategic firms or are spun-out by banks facing regulatory issues. As a result, alternative manager deals are on track to outpace traditional manager deals for the first time.

Financial Regulatory Reform and the “Volcker Rule”: The limitations imposed on proprietary trading and PE / HF sponsorships already have caused global reevaluation of the diversified bank business model, with Citigroup and Bank of America selling PE / HF business units.

UCITS: UCITS III hedge fund sector now takes up 7% of the total HF industry. There is no sign of its growth slowing. We see an increase in its use by non-European firms who wish to access the European capital markets.

Source: Springtime for M&A in Alternative Investments? Part 2