* Three consultants among top 10 fund of hedge funds
* Fund of hedge fund industry grows 16.5 pct since 2009
* Fund of hedge funds start to offer more services
By Joshua Franklin and Simon Jessop
LONDON, April 27 Funds that invest in a range of hedge funds are facing a battle to win new business, as the same consultants they court to win money from pension firms are grabbing a chunk of an industry that was already struggling to grow.
So-called fund of hedge funds are designed to give investors an easy way of putting money into hedge funds, offering to spread their risks and do research into the individual hedge funds for them.
But sliding asset prices during the financial crisis and the fallout of the Bernie Madoff fraud scandal saw billions of dollars exit fund of hedge funds, leading many to close or merge.
Over the past few years, those that remain have found consultants - who have built up expertise after years of vetting fund of hedge funds for institutions - are now investing directly into funds on behalf of some large-scale clients.
Trade publication InvestHedge found three consultants - Mercer, Cambridge Associates and Towers Watson - were among the 10 biggest fund of hedge funds by assets as of the end of 2013, representing 12.6 percent of the $728 billion held by fund of hedge funds with assets worth at least $1 billion.
"In new allocations to the industry ... consultants are active in gaining mandates," said Joachim Gottschalk, chairman and chief executive of hedge fund firm Gottex.
The increased competition is particularly significant, because the industry is struggling to grow.
The value of assets held by fund of hedge funds worth at least $1 billion has risen by just 16.5 percent since 2009, according to InvestHedge, and remains well below the peak of just over $1 trillion hit in 2007.
The hedge fund industry on the other hand is booming - total assets under management are at historic highs after rising by almost two thirds over the same period, data from industry tracker HFR showed.
Fund of hedge funds have voiced concerns over a potential conflict of interest in cases where they pitch strategies to consultants that are also in competition with them.
But consultants argue they have internal measures to prevent the sharing of confidential information.
"Those individuals responsible for researching hedge fund of funds and the research they conduct is Chinese walled off from the rest of the business," said Dan Melley, UK head of fiduciary management at Mercer.
Fund of hedge funds have traditionally relied on high net-worth individuals. But in recent years, institutional investors have become a bigger part of the industry's client base, handing an advantage to consultants, many of which have long relationships with pension funds and other institutions.
Deutsche Bank's Alternative Investment 2014 Survey found the proportion of respondents from the fund of fund industry - of which fund of hedge funds are a part - who said more than half of their assets under management in 2013 came from institutions was 63 percent, up from 53 percent in 2008.
Many fund of hedge funds have adjusted to the new landscape, increasing the services they offer instead of simply selling fund of hedge fund portfolios.
"Before it was very formatted," said Nicolas Rousselet, managing director at Swiss investor Unigestion. "They had fund of funds or direct hedge funds ... Now it's much broader."
Many fund of hedge funds now provide co-management services for investors looking to play a more active role in their portfolio, fiduciary services for clients who want to keep their investments at arm's length, and advisory offerings for clients investing directly.
This has made the traditional fund of fund compensation structure - a 1 percent management fee and a 10 percent performance fee - a thing of the past.
"Increasingly any fund of fund that has any institutional business is in effect changed into a consulting firm," said Peter Douglas, founder of Singapore-based hedge fund consultancy GFIA.
"The idea that any capital owning institution is going to pay 1+10 for a commingled portfolio of hedge funds is yesterday's story." (Additional reporting by Nishant Kumar in Hong Kong; Editing by Mark Potter)