Fund of hedge Funds
The universe of Fund of Funds (FoFs), often referred to as Fund of Hedge Funds, continues to grow from Year 2000, both in absolute terms and as a relative component of Hedge Funds. FoFs currently account for well over one third of the Hedge Fund industry. Most of this growth has remained in the US and the UK. In the rest of Europe, it is the fastest growing investment product. One of the main reasons of this growth is its ability to offer investors access to Hedge Funds that are closed long back and invest after regress due diligence process.
What is Fund of Funds or Fund of Hedge Funds?
Fund of Funds are portfolios of Hedge Funds offering small investors with minimal investment exposure to a wide range of alternative Hedge Funds investment styles and strategies. FoFs generally allocate capital to 15-30 Hedge Funds to achieve efficient risk diversification; this feature also attracts institutional investors to invest in FoFs. Nevertheless, a smaller number of Funds may be used to concentrate capital on a particular strategy. Such FoFs aim to post high returns and are more concerned with event risks. However, FoFs manager investment style can be classified as below:
FoFs classified as conservative have two characteristics. First, it seeks for consistent returns by primarily investing in funds that have conservative strategies such as equity market neutral, fixed income arbitrage and convertible arbitrage, and secondly exhibits a lower historical volatility than the average FoFs' composite Index. A conservative FoFs generally shows consistent performance regardless of market conditions.
Here, the FoFs manager creates a "diversified" portfolio of various Hedge Funds with a balanced risk posture. Many Fund of Funds utilize a multi-strategy approach, which includes both aggressive and conservative Hedge Funds without specific importance to any single Fund.
Market defensive FoFs invest in funds that generally engage in short-selling bias strategies and managed futures. The portfolio shows a negative correlation to the general market benchmarks and shows higher returns during market decline.
The strategic FoFs generally engage in investing more opportunistic strategies such as emerging markets, sector specific, and equity hedge with the motive of creating superior returns for investors. These funds exhibit a greater dispersion of returns and higher volatility compared to FoFs benchmark.
One important item in Hedge Fund industry is the Hedge Fund fee structure, which is a key distinguishing feature of Hedge Funds from other investment alternatives. Hedge Funds always have a fee structure that includes both a management fee and an incentive or performance fee. The management fee usually ranges between 1 percent to 2 percent of assets under management and the incentive fee between 15 percent and 25 percent of upside performance. Most Hedge Funds follow the "2 and 20" rule - a 2 percent annual management fee and a 20 percent annual performance fee. This fee structure creates serious incentive for portfolio managers to generate positive returns. If they can't, investors only have to pay the management fee until the Fund's provide profit.