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A Fund
of Funds, by definition, is one that invests in other hedge
funds. Rather than investing in individual securities, a Fund
of Funds invests in other hedge
funds. Any fund that pools capital together, while utilizing two or
more sub managers to invest money in equity, commodities, or currencies,
is considered a Fund
of Funds. Investors are allocating assets to Fund
of Funds products mainly for diversification amongst the different
managers' styles, while keeping an eye on risk exposure.
Fund
of Funds are structured as limited partnerships, which afford advantages
to the investor. One is advantage is due diligence. Due diligence is a
primary advantage because the fund
of funds manager may spend his whole day evaluating strategies and
speaking with individual fund managers. This would be an extremely hard
task for an individual. The fund
of fund also may combat risk by achieving manager diversity, because
of the different strategies employed by the underlying managers. For example,
some fund
of funds may have exposure to a long/short fund, a distressed fund,
and a private equity fund. By investing within the fund
of funds, the investor is given the opportunity to have a unique asset
allocation product, while trying to limit the risk on the downside.
Fund
of Funds have some drawbacks however. The first to come to mind is
the double layer of fees. When dealing with fund
of funds, an investor must understand that the underlying funds charge
a fee, as well as the fund of funds manager. This translates to "layers"
of fees before the investor receives dollar one. Transparency issues are
also important. Research such as the individual manager's background and
reputation, not to mention the nature of the investments that they are
utilizing, are all issues a fund of fund manager must investigate. Therefore,
you are relying on the fund
of fund manager's talent and expertise in choosing managers, when
investing in a fund
of funds. Investors look for Fund
of Fund because hopefully they provide more stable returns while reducing
risk.
Related Reading:
What is a
Hedge Fund?
Timing and
Your Investment Decisions Revised
Hedge
Fund Performance
Why
Hire a Hedge Fund Administrator?
Domestic
Hedge Funds or Offshore Hedge funds
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