Fund of Funds Investing: A Roadmap to Portfolio Diversification

Chapter 11. Recent Lessons Learned and Current Trends

The period 2006–2008 may go down in history as one that exemplified all that was wrong with Wall Street, Main Street, and global financial systems. In other words, just when you think you've seen it all, a tsunami strikes, and worlds and lives change in an instant. Fingers may be pointing for many years to come about who did what to whom and when; the subprime crisis and the subsequent credit freeze can be attributed to the excessive greed exhibited by all parties, including hedge funds, hedge fund investors, and the banking and mortgage industry.

Although some hedge fund investors may point to hedge funds that "took advantage" of their investors during this period, investors were more than satisfied with superior returns but did not ask "Why is my manager doing so much better than others." Alternatively, a better outcome may have been achieved by investors who believed that everything trades at a price for a reason and asked why the actual returns or projected returns were higher than historic industry averages.

A key principle of hedge fund investing is that hedge fund risk is different from traditional asset management risk because of

• The use of leverage

• The ability of the manager to short

• Reduced transparency

• The cultural background of managers to assume greater or different risk

However, as most investors understand, to make money you have to take some risk. Market-neutral managers who profess to make money consistently may not ...