The Case for Funds of Hedge Funds |

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The Case for Funds of Hedge Funds

Why institutional investors should still consider them

Funds of hedge funds (FoFs) were once a significant way for investors to gain access to hedge funds, but since 2008 their reputation has suffered, their total assets and market share have shrunk (there were 30% fewer FoFs in 2014 than in 2007, representing approximately 14% of overall hedge fund assets as of Q3 2015 versus approximately 36% in 2007), and many of the better known ones have disappeared or have had to merge in order to survive.

In the aftermath of 2008, many investors have decided that they would directly invest into single-manager hedge funds instead, and that the services offered by funds of funds were no longer of use to them. The mere mention of funds of funds with investors these days can lead to raised eyebrows and questioning looks. After all, why would anybody suggest employing an investment strategy that charges an extra layer of fees, and that by and large has underperformed over the past few years?

A superficial analysis of the topic may well lead investors to such a conclusion. However, we strongly feel that funds of funds can still be an extremely valuable tool for investors, and that the right ones still very much deserve a place in investors’ portfolios. Therefore, in order to arrive at a meaningful conclusion, we need to examine not just the different potential benefits that a FoFs approach may yield, but to also to take a very close look at the cost side of the equation, one of the main criticisms levelled against FoFs.1

To build or buy?

Let’s start with the fee criticism and the perceived double layer of fees. The argument here is that by levying additional management and/or performance fees on top of the fees already charged by underlying hedge funds, the final product ends up with a very high total expense ratio, which may mean that little could be left over in terms of net performance or added value for investors. Though this may be the case for some funds of funds, especially those investing in managers that are already well known to many hedge fund investors, with arguably little added value coming from their research process, it isn’t necessarily true for all. Many funds of funds actively apply their own macro view, employ a thematic approach, a geographic focus or actively trade the managers in their underlying portfolios, thus offering additional benefits and expertise beyond simply picking easily accessed and well-known hedge funds. Therefore, investors need to look at different aspects of this cost argument, each of which we feel it is important to discuss in more detail.

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About The Hedge Fund Journal

INFORMING THE HEDGE FUND COMMUNITY With access to some of the industry’s biggest names and an astute and talented group of writers and contributors, The Hedge Fund Journal has established itself as a trusted source of information on the hedge fund industry.