1. Hedge Funds: Introduction
  2. Hedge Funds: Structures
  3. Hedge Funds: Strategies
  4. Hedge Funds: Characteristics
  5. Hedge Funds: Performance Measurement
  6. Hedge Funds: Risks
  7. Hedge Funds: Why Choose Hedge Funds?
  8. Hedge Funds: The Due Diligence Process
  9. Hedge Funds: Funds Of Funds
  10. Hedge Funds: Conclusion

By Dan Barufaldi

Funds of hedge funds are an alternative to investing directly into individual funds. There are advantages and disadvantages to funds of funds, and the benefits to an investor are completely dependent on the investor. Funds of funds are well diversified investment vehicles made up of a variety of other funds. They typically have lower minimums and are a good way to invest in hedge funds with broad diversification. Some funds of funds invest in hedge funds with a variety of different strategies and a much higher level of diversification, while others, called single-strategy funds, will invest in a variety of funds having the same or similar strategies.

One of the benefits of fund of funds is that they enable an investor to obtain instant diversification in a portfolio of hedge funds, which is particularly attractive for an investor with a portfolio that is large enough to invest in hedge funds, but too small to achieve proper diversification going directly into hedge funds. For example, with hedge fund minimums often starting at $1 million, it would be difficult for an investor with a $2 million account to diversify their portfolio of hedge funds. The maximum number of hedge funds they could invest in is two, and that would not be a very prudent diversification strategy. A fund of funds, however, that is invested in 15-20 hedge funds and has a minimum investment of $500,000 enables the investor to gain exposure to the alternative asset class without compromising the overall structure of the portfolio.

As mentioned, some funds of funds are single-strategy funds, while others make investments in funds using a variety of different strategies. The multi-strategy funds provide broader diversification and uncorrelated returns within underlying funds. The investor in this case relies on the skill of the fund manager to allocate the portfolio to appropriate strategies and to monitor and tactically adjust the portfolio as needed. An investment in a quality multi-strategy fund of funds is also appropriate for investors who do not have the skill or resources to determine which strategies are attractive in the current environment.

The single-strategy fund of funds, on the other hand, would require an investor decision to add exposure to a particular type of strategy. I would hope that this type of investor has the resources to evaluate such a decision and make an allocation to this fund after careful evaluation of the overall portfolio.

It is important to assure that the fund of funds has well diversified funds even though they may use the same strategy. For example, if evaluating a long/short fund made up of 15-20 funds, it would be prudent to understand the sub-categories of each of the funds, such as whether they are sector-specific, domestic or global, value or growth-oriented, the level of gross and net exposure inherent in their strategy, and others. Most funds of funds will do a good job of diversifying across a variety of sub-strategies, but an investor should make sure this is the case. (You can learn more about these investments at Fund Of Funds – High Society For The Little Guy and Hedge Funds Go Retail.)

Hedge Funds: Conclusion

Related Articles
  1. Investing

    Hedge Funds Go Retail

    Find out how average investors are breaking into what was once reserved for the ultra rich.
  2. Investing

    Evaluating Hedge Fund Performance

    Most investors are aware of hedge funds, but many don't know the dirty details of this unique investment type.
  3. Investing

    Hedge Funds: Higher Returns Or Just High Fees?

    Discover the advantages and pitfalls of hedge funds and the questions to ask when choosing one.
  4. Investing

    Fund Of Funds - High Society For The Little Guy

    Like a mutual fund, FOFs provide instant diversity by grouping many hedge funds into one product.
  5. Investing

    Hedge Funds' Higher Returns Come At A Price

    Learn how hedge funds win big gains for investors - and why they sometimes lose.
  6. Investing

    Understanding a Hedge Fund Manager's Worth

    Hedge funds pool investors’ money much like mutual funds. However, they are not as closely regulated as mutual funds, and although their investments may include stocks, bonds and other traditional ...
  7. Investing

    6 Reasons Hedge Funds Underperform

    Understand the hedge fund industry and why it has grown exponentially since 1995. Learn about the top six reasons why the industry underperforms.
  8. Financial Advisor

    Advising FAs: Explaining Mutual Funds to a Client

    More than 80 million people, or half of the households in America, invest in mutual funds. No matter what type of investor you are, there is bound to be a mutual fund that fits your style.
  9. Managing Wealth

    Will Hedge Funds Be Around in 10 Years?

    Learn why some analysts see hedge funds as a dying breed, especially after a torturous January 2016 for fund managers around the world.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center