Guide to Hedge Funds: What they are, what they do, their risks, their advantages, Second Edition

Chapter 3

Funds-of-funds

Hedge fund fees are high enough to raise questions about whether they make more money for themselves than for their clients. But that is not the only problem for potential investors. Most access the sector via a fund-of-funds manager, which charges a further layer of fees on top. All told, investors could end up paying annual fees of three percentage points even before worrying about performance fees. That is a big hurdle to overcome.

So why do investors bother? Two factors are probably most influential:

• The time and expertise needed to analyse a range of sophisticated hedge fund strategies. Such costs might easily equal the extra fees paid to a fund-of-funds manager, at least when an investor is in the process of setting up a hedge fund portfolio. One academic cites $50,000 as the cost of due diligence on an individual hedge fund.1 Or, as one investor put it: “There are no yellow pages for hedge funds.”
• The comfort blanket a fund-of-funds manager can provide. At the very least, investors should expect the fund-of-funds manager to spot the fraudsters. They might also expect the manager to avoid those funds that were taking excessive risks – Man Group’s RMF arm held money with Amaranth Advisers and, later, with a feeder fund linked to Bernie Madoff. Of course, those managers who avoided both disasters will have used the fact as a marketing opportunity.

Nevertheless, the Madoff scandal did cause some to question the whole future of the fund-of-funds industry. ...