CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

38.1 APPROACHES FOR ACCESSING HEDGE FUNDS

There are three approaches for investors to obtain hedge fund exposure in their portfolios: self-managed (directly accessing hedge funds), delegated (investing through FoFs), and indexed (investing in index-type products).

The self-managed approach consists of investing directly in a series of hedge funds. Unfortunately, this approach may be a bit difficult for smaller investors, who may be constrained by the minimum wealth levels and sophistication standards required by regulators in many countries to invest in hedge funds. In addition, with more than 7,000 hedge funds globally, this approach requires extensive resources to research the market, as well as sufficient experience and expertise to determine the appropriate blend of strategies and managers, and to monitor them. However, even with these obstacles, more and more institutional investors are choosing to invest directly into hedge funds for a variety of reasons. These reasons include the avoidance of the extra layer of fees charged by a fund of funds, as well as the ability to gain greater control and transparency in the asset allocation and due diligence process than would be possible in the delegated approach.

The delegated approach consists of buying shares in an FoF. Funds of funds serve the following functions:

• Portfolio construction. Once the strategies and managers have been selected, the FoF manager has to decide on how much to allocate to each strategy and manager. The ...