Global assets of hedge funds may drop to $1.2 trillion by the end of the first quarter, down 35 percent from 2007 as the number of managers decline and funds rely less on strategies that use leverage, a UBS executive said on Tuesday.

We are gonna see a reduction in hedge fund assets, we are gonna see decline in the number of hedge funds, we are gonna see some strategies that will not work in this environment, Timothy Bell, global head of hedge funds advisory at UBS Wealth Management, told reporters in Singapore.

Hedge funds had assets worth $1.9 trillion at the end of 2007, which peaked at $1.93 trillion in the middle of 2008, according to data from Chicago-based Hedge Fund Research. These assets dropped to $1.4 trillion at the end of 2008.

Investors pulled $155 billion out of hedge funds last year, punishing the once hot asset class for delivering its worst-ever returns of nearly 21 percent, data shows.

Bell said investors could benefit from contraction in the industry because there would be less capital and better managers chasing opportunities that could drive absolute return, as well as less focus on investments that rely on heavy borrowings.

Macro strategies on economic outlook, managed futures and the traditional long or short strategies would be in focus, he said.

Bell said investors could see better terms for less liquid strategies such as arbitrage and distressed debt.

The HFR Fund of Funds Composite Index dropped 20.68 percent in 2008, the industry's worst ever losses, hit by declining stock markets, sharp volatility in oil markets, the collapse of Lehman and temporary restrictions on short selling.

Hedge funds started the year with small gains, outperforming a declining stock market in January.

(Reporting by Saeed Azhar; Editing by Anshuman Daga)

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