Hedge Funds of Funds: A Guide for Investors

6

The Hedge Funds of Funds Investment Process

6.1 OVERVIEW

In this chapter we take a detailed look at the typical investment process of a good hedge fund of funds and, for those readers who have an interest in hedge fund investing, take a look at some ‘tips of the trade’. As we have already seen, this isn't just about picking good hedge fund managers but also covering a range of bases, namely:

• Strategy Analysis and Allocation
• Sourcing and Capacity Negotiation
• Quantitative Analysis
• Qualitative Analysis
• Operational Risk Assessment and Referencing
• Portfolio Construction
• Critical Analysis and Decision Process

6.2 STRATEGY ANALYSIS AND ALLOCATION

However skilled a hedge fund manager is, he will find it difficult to generate returns if the strategy he practises is doing badly and it will be tough to outperform hedge funds in better placed strategies. As a result, it's not good enough for hedge funds of funds just to ‘pick good hedge funds’ – they need to consider their allocations to hedge fund strategies as well.

It is important that a hedge fund of funds has considered how to allocate to strategies and that there is a formal process in place. In some hedge funds of funds there are separate teams to consider strategy allocation but this is unusual as in order to consider a strategy's outlook, one needs to be actively talking to hedge funds and so it is often the hedge fund of funds' portfolio managers and other senior investment professionals that make the strategy based decisions. ...