Fund of Funds Investing: A Roadmap to Portfolio Diversification

Chapter 4. Hedge Fund Investing

The crossover or convergence of hedge funds and private equity has provided new opportunities for investors and managers to work together and extract profits from the markets. However, as the convergence has occurred, investors have raised many questions and concerns about how their money is being managed. All marketing material for hedge funds, as well as for other investments, states "past performance is not indicative of future results." In the changing environment, investors are betting on better future results.

PRICING PROBLEMS

One of the challenges of hedge fund investing is subjective and periodic pricing of the portfolio. Pricing of the individual positions in portfolio or "marking to market" can be a complex issue for illiquid or less frequently traded securities (i.e., private equity holdings). Managers will generally use pricing obtained from publicly available sources as well as from proprietary sources from the prime brokers or administrators. The Wall Street dealer community also provides pricing data to the manager. In less liquid or illiquid positions, the challenge is different.

To standardize the pricing and reduce the need to manage pricing and monthly performance results, the Financial Accounting Standards Board (FASB) introduced FASB 157 for Fair Value Measurements to define fair value within the annual auditing process. The purpose is to reduce the risk of mark to market bias by managers by addressing three issues: definition of ...