Hedge Funds of Funds: A Guide for Investors

4

Investing in Hedge Funds Through a Hedge Fund of Funds

4.1 OVERVIEW

In this final chapter of Part I, I aim to explain what a hedge fund of funds actually does. I will take a closer look at the functions carried out by a hedge fund of funds and consider the upsides and downsides in accessing hedge funds in this way.

4.2 WHAT DO HEDGE FUNDS OF FUNDS DO?

Hedge funds of funds are widely believed to be just ‘hedge fund pickers’ and nothing more. Selection of outperforming hedge funds is, of course, a fundamental part of what hedge fund of funds do. However, there are many more areas that need to be covered in order to run a successful hedge fund of funds, as we see below.

• Combining the appropriate strategies to form the desired return stream
  • Before even constructing a hedge fund of funds portfolio, bespoke or otherwise, a hedge fund of funds manager needs to assess the needs and constraints of the intended investors to ensure the profile of expected returns and risk is appropriate. For example, if a particularly downside controlled portfolio is required then there would be a bias towards market independent strategies such as relative value, which tend to be involatile. However, this would not just be a matter of investing with all ‘low volatility’ strategies since some of the least volatile ‘static return’ or ‘yield based’ strategies have potential for significant downside. Thus the consideration of which strategies to use is far from straightforward.
• Strategy allocation
  • A hedge ...