Fund of Funds - Fund of Hedge Funds

A fund of hedge funds is a fund of funds that invests in a portfolio of different hedge funds to provide broad exposure to the hedge fund industry and to diversify the risks associated with a single investment fund. Funds of hedge funds select hedge fund managers and construct portfolios based upon those selections. The fund of hedge funds is responsible for hiring and firing the managers in the fund. Some funds of hedge funds might have only one hedge fund in it, this lets ordinary investors into a highly-acclaimed fund, or many hedge funds.

Funds of hedge funds generally charge a fee for their services, always in addition to the hedge fund's management and performance fees, which can be 1.5% and 15-30%, respectively. Fees can reduce an investor's profits and potentially reduce the total return below what could be achieved through a less expensive mutual fund or exchange-traded fund (ETF).

While funds of funds conceptually can provide extremely useful services for many hedge fund investors, they have been criticised for the significant incremental costs they impose. (The underlying hedge funds usually charge fees of between 1 and 2% of assets managed and incentive fees of 15–25% of profits generated. The funds of funds typically add additional fees of 1% and 10%, respectively). Moreover, fund-of-funds behavior has often exhibited crowd-following tendencies, suggesting the managers of these funds prefer to match indices rather than seek opportunities.

The industry has recently been criticized by some hedge fund managers for a reputation of holding a short-term view. Some hedge funds have even started turning away fund of hedge funds money. “It is really beginning to irritate those funds of hedge funds that approach their investments sensibly,” says one fund of hedge funds manager.

The first fund of funds was started by the Rothschild family in Europe in 1969 under the name Leveraged Capital Holdings. In 1971, Richard Elden founded Grosvenor Capital Management in Chicago, Illinois, introducing the concept of fund of funds to the United States.