Investment flows into hedge funds have turned net positive and the sector is heading toward having assets under management of around $1.75 trillion by year-end, according to Morgan Stanley.

That would take them back up to levels last seen in the second quarter of 2007, it said.

The investment bank said in a note dated on Thursday that hedge funds were set for renewed growth because investors had begin to focus on risk-adjusted returns.

It noted, for example, that inflows into such funds in Britain were around $2.1 billion in the third quarter, three times what they were in the first quarter of the year.

We think the market is underestimating the potential upsurge in demand for absolute return funds from private clients and smaller institutions via UCITS lll, Morgan Stanley said, referring to a European fund regime that makes it easier to sell funds across the continent and also provides more transparency.

Morgan Stanley also said its research showed sovereign wealth funds, foundations and pension funds were now the biggest source of funds for hedge funds, having eclipsed endowments and funds of hedge funds for high net worth investors.

United kingdom Investment Morgan Stanley