Here’s how George Van sees the hedge fund business: “Fasten your seat belt – this thing is going to go.” Mr. Van should know. As founder of the Van Companies, he keeps in touch with hundreds of top funds and has led his company’s research and consultancy efforts with hedge managers and investors since 1992.

Mr. Van recently surveyed the state of the industry in a report titled “Is Worldwide Hedge Fund Demand Outstripping Capacity?” At a time when many are pointing to diminished returns and outright frauds (like Bayou Management) as possible harbingers of a downturn in the hedge world, Mr. Van paints a rosy outlook indeed.

He projects that the industry is going to continue to grow like topsy, that it is not excessively leveraged, that fees are becoming even more aggressive, and that there are a number of new investment vehicles that will soak up some of the inflows.

The central issue raised by the report is the explosive growth in hedge fund assets in recent years, and the seeming pressure applied by the expansion to certain investment strategies. In other words, there has been, in some sectors, too much money chasing too few opportunities.

The result, of late, has been narrowing returns and disappointed investors. This unhappy turn of events was seen quite visibly in 2004, when huge inflows combined with low volatility led to the industry underperforming the S&P 500. Specifically, the Van Global Hedge Fund Index was up 7.7% compared to an S&P gain of 10.9%.

This underperformance, however, had little impact on investors’ appetite for hedge funds. Why? Call it momentum. Scads of committee-bound institutional investors are now just beginning to investigate hedge funds, having seen their peers run circles around them for many years.

According to the Van group report, hedge fund assets doubled between 1999 and 2004, to about $950 billion. From 1988 through 1998, the industry grew at 24% a year. Astonishingly, pension plans, with $5 trillion in assets, have to date committed only about 1% of their assets to hedge managers. About 20% of pension managers have made a hedge investment, compared to 60% of American foundations and endowments.

Without a doubt, pension managers will be tumbling into hedge funds. These pools of money are woefully underfunded, in part because their assumed investment returns have been overly optimistic. Underfunded pension plans are not just an American phenomenon. According to the Van group, capital debts of global pension organizations total as much as $1.5 trillion.

What does this mean for hedge managers? According to Mr. Van, American institutions have about $70 billion with hedge managers today. If they move to a 15% allocation, hedge fund assets would more than double. Another $850 billion would stem from non-U.S. pension plans adding 10% to their allocation.

Mr. Van’s report forecasts that hedge fund assets will total $2 trillion by 2009 and will reach $6 trillion by 2015.

As a result of the push from pension funds and increased interest from retail investors, there also has been huge growth in fund of funds. They estimate that in 1990, there were only 50 FOFs worldwide. Today they estimate the figure to be 3,000, managing $400 billion, or about 40% of industry assets. Extrapolating recent trends, the Van group predicts that eventually there will be more FOFs than there will be underlying funds.

A possible negative aspect of the FOF outlook, however, is the rise in underlying fees. Just two years ago, the industry was routinely charging 1% of assets and 20% of profits. Now, for some successful funds like Bruce Kovner’s Caxton, the new structure is “3 and 30.” Imagine investors paying an FOF fee on top of that.

Dispelling a common myth, the Van group concludes that hedge funds are not using excessive leverage. Based on conversations with prime brokers and practitioners, the Van authors point out that 20% of hedge funds use no leverage at all, and another 50% are levered less than 2-to-1.

What was the biggest surprise in researching the report? Mr. Van comes away from the project convinced that the majority of assets invested in hedge fund products will be in public vehicles in the “not-too-distant future.” Though he can’t today say what form that public vehicle will take, he ties this development with the increased speculation about many of the larger hedge funds going public. He thinks this trend, too, is inevitable.

Overall, he considers the industry to be at a tipping point. This is the same fellow whose 1990s forecast of $1 trillion in hedge assets by 2005 was greeted with skepticism. Is your seat belt fastened?