Alternative Investments - Fund of Funds Investing

Any fund that pools capital and uses two or more sub managers to invest that capital - whether it is debt, equity, commodities, derivatives, or currencies, is a fund of funds. Any combination of the above instruments may be used depending on the objectives of the fund. Because of the loose definition of this term, a pension fund or an endowment fund can be considered a fund of funds. But for clarity, we'll concentrate on a fund of funds as it relates to other hedge funds. By its very nature, a fund of funds does not make direct investments, and it is known as a "look through" vehicle. The fund of funds manager spends considerable time evaluating and identifying strategies and selecting the hedge funds to implement them. Depending on the expertise of the fund of funds manager, this can yield superior investment results. Ordinarily, a fund of funds is structured as a limited partnership.

Benefits:

  1. Retailing - Allows an investor access to a large number of hedge funds.
  2. Access - May be able to allow investors into funds that are already closed to new investors if the fund of fund already has cash placed with a particular manager.
  3. Diversification - Allows investors to diversify the risk of a single hedge fund by investing in several types of hedge funds. A fund of funds can control risk by achieving manager diversity. They accomplish this by diversifying in the strategies those managers employ. To the investor, this allows them to participate in a unique asset allocation mechanism while hopefully limiting downside risk.
  4. Expertise - Managers should have better knowledge and experience in picking successful hedge fund managers.
  5. Due Diligence Process -This process is very time consuming and highly specialized. A fund of funds manager should be exceptionally experienced and well equipped to perform this process.


Fund of funds are not without disadvantages, however, and we would be remiss not to discuss them.

Drawbacks:

  1. Fee - An investor in a fund of funds is required to pay an additional layer of fees. Usually, these fees range from 1-2% of assets, but some fund of funds charge a performance fee, too. However, the SEC limits the number of fees an investor can pay.
  2. Performance - The hedge funds in the fund of funds are usually chosen by their past performance, which tends to give little indication of future performance. It is wise to remember that a fund of funds is only as good as its manager and the underlying funds it invests in.
  3. Diversification is a two-edged sword - Blending various types of hedge funds may reduce your exposure; however, you'll be subject to higher fees and disparate returns.
Alternative Investment Valuation
Related Articles
  1. Career Education & Resources

    How Hard are the CFA Exams?

    Learn about the difficulty of the CFA exams with a description of the tests, some statistics on pass rates and suggestions that can help you pass the exams.
  2. Professionals

    What it Takes to be a Financial Analyst

    A financial analyst researches companies and economic conditions to make business, sector and industry recommendations.
  3. Career Education & Resources

    Financial Analyst: Career Path & Qualifications

    Read about what it takes to become a financial analyst in a corporation or securities firm, and learn how far you can rise in the profession.
  4. Career Education & Resources

    Financial Planner: Career Path & Qualifications

    Learn what education and certifications you need to become a financial planner, as well as the future prospects and earnings potential for financial planners.
  5. Career Education & Resources

    Where to Find Non-Profit Finance Jobs

    The non-profit sector offers a stable selection of jobs for those who seek other types of fulfillment from their jobs than just purely financial.
  6. Career Education & Resources

    Portfolio Manager: Career Path & Qualifications

    Learn about the basic requirements for getting hired as a portfolio manager, and discover how most professionals in the field rise into the position.
  7. Your Practice

    4 Professional Associations Advisors Should Join

    These four professional organizations are among the most respected and well known in the industry.
  8. Professionals

    Equity Research: Career Path and Qualifications

    Find out what equity research analysts do on a day-to-day basis, and learn more about the typical career progression for these securities professionals.
  9. Professionals

    What's on the CFA Level II Exam?

    The Chartered Financial Analyst Level II exam is the second of three tests that CFA candidates must pass.
  10. Professionals

    Financial Data Analyst: Career Path & Qualifications

    Learn more about the career options available to financial data analysts, and determine whether the profession is a good match for you.
RELATED TERMS
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  4. Security Analyst

    A financial professional who studies various industries and companies, ...
RELATED FAQS
  1. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  2. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
  3. What types of positions might a Chartered Financial Analyst (CFA) hold?

    The types of positions that a Chartered Financial Analyst (CFA) is likely to hold include any position that deals with large ... Read Full Answer >>
  4. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  5. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ... Read Full Answer >>
  6. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ... Read Full Answer >>
Hot Definitions
  1. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  2. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  3. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  4. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  5. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  6. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
Trading Center