Alternative Investments: CAIA Level I, 3rd Edition

CHAPTER 21 Funds of Hedge Funds

The preceding five chapters have described the universe of hedge funds and its constituent categories of macro and managed futures, event-driven, relative value, and equity strategies. Few investors allocate their entire hedge fund investment to a single hedge fund manager or even a single hedge fund strategy. Investors realize that each manager and each strategy has its own specific risks and cyclicality of returns and that diversification across managers and strategies can reduce the risks of hedge fund investing.

The hedge fund industry includes funds of funds (FoFs) as well as single-manager funds. Funds of funds are hedge funds with an underlying portfolio of other hedge funds. The primary advantages of a fund of funds are diversification, professional manager selection, and portfolio management processes. The primary disadvantage of a fund of funds is a second layer of fees imposed by the fund of funds manager.

Investors may also want to consider multistrategy funds, which manage multiple strategies within a single entity. Multistrategy funds offer strategy diversification without the additional layer of fees, but there are also trade-offs involved when selecting these funds.

21.1 Overview of Funds of Hedge Funds

A fund of hedge funds is a diversified fund run by a single hedge fund manager, in which assets are allocated among other hedge funds. This structure creates two layers of fees: the fees of the fund of funds structure, and the ...