Fund of Funds Investing: A Roadmap to Portfolio Diversification

Chapter 6. Why Fund of Funds Work

The primary investors in fund of funds are high net worth investors, family offices, foundations and endowments, and institutional investors. This is essentially the same investor base as hedge funds have, with the newest large entrants being public and corporate retirement pension funds globally. Hedge fund investors are typically looking for an investment vehicle that meets one of the following requirements:

• No or low correlation to the public debt and equity markets

• Outperformance (i.e., no losses) in down markets, while capturing a significant portion of upside returns when the market rallies

• Investment in sectors that are not user friendly to investors that lack specialized skill sets (fixed income or credit) or may not have a team of investment professionals analyzing individual hedge fund strategies

• Intention to invest in hedge funds to lower overall portfolio volatility and market exposure

THE EARLY ADOPTERS

Early institutional adopters of hedge funds in the 1990s were foundations and endowments. Historically, this group has been more visible in hedge fund investing than most other institutional investors, given that there is a requirement to make distributions of a fixed percentage of assets annually—and higher—consistent returns were required to meet this stated mandate.

Family offices with substantial assets were also early to invest in hedge funds and fund of funds. While the global macrostrategy employed by famed hedge fund managers George ...