Hedge fund investors are pessimistic about the year ahead, and they are expecting the strongest returns from emerging markets, according to a survey by Deutsche Bank.

The bank reported that 80% of investors it surveyed are bearish for 2008. However, they are more optimistic for next year, with 40% expecting the global economy to pick up in 2009.

Hedge fund investors predict that macro, distressed, and equity volatility will be the top performing strategies for 2008. The majority of investors surveyed also plan to increase their allocations to emerging markets, with the Middle East as the predicted top performer amongst all regions.

“Hedge fund investors’ prediction that the Middle East and North Africa will be the top performing region in 2008 indicates a clear redistribution of capital towards emerging markets,” said Sean Capstick, London-based co-head of the Hedge Fund Capital Group. “The survey also shows that the number of early stage investors has fallen by 25% in the past year, making 2008 a more challenging environment for startup funds.”

Additionally, the survey noted that for the first time investors have added ‘risk management’ as a major manager selection criteria, in addition to investment performance, investment philosophy and manager’s pedigree.

“Hedge fund investors are cautiously poised, as shown by their increased focus on risk management and plans to allocate to strategies which are not sensitive to equity market risk,” said Maarten Nederlof, New York-based co-head of the Hedge Fund Capital Group. “We also found that despite their overall bearish outlook on the economy, investors predicted more than $200 billion will flow into the industry.”

Cash levels are high as investors take a “wait and see” approach to hedge fund investing, the bank noted. However, 53% of investors holding cash now plan to eliminate their cash holdings over the next 12 months, suggesting a renewed focus to make allocations to hedge funds. It also observed that 70% of hedge fund investors do not currently use or apply leverage to their portfolios; 30% are actively leveraging their portfolios, including 6% through structured products.

The survey, which was conducted during March, contacted over 1000 respondents from 500 institutions, including banks, corporations, insurance companies, consultants, family offices, high net worth individuals, wealth management companies, funds of funds, pensions, endowments and foundations.