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

38.2 CHARACTERISTICS OF FUNDS OF HEDGE FUNDS

An FoF is essentially an investment vehicle that pools the capital of a number of investors and allocates the capital to many different hedge funds with the goal of diversifying across a range of styles, strategies, and managers. When investing in an FoF, investors delegate the management of their portfolios to the FoF.

The FoF manager is in charge of selecting individual hedge funds, performing a complete due diligence on each manager, obtaining capacity, monitoring risk and return, managing the overall portfolio, and reporting performance and other information to the investors.

According to Hedge Fund Research, there were 2,001 FoFs reporting to their database at the end of Q4 2011, versus 80 FoFs at the end of 1990 and 538 FoFs at the end of 2000. These FoFs controlled over $629 billion by the fourth quarter of 2011, which is almost one-third of the hedge fund industry's assets (estimated at $2,008.1 billion). Their success was initially fueled by smaller investors who did not have the capital and resources to invest directly in hedge funds. More recently, the interest has been fueled by institutional investors that are new to the alternative investment industry (e.g., pension funds, endowment funds, private banks, and family offices). These investors may prefer to use an FoF for their first allocation as a way to learn about the portfolio construction and due diligence processes required to build a direct hedge fund portfolio. As ...