Fund of Funds – The bridge that never was
Funds of Funds are typically seen by investors as experts in picking the right (alternative) investment target s- hedge funds – in all market cycles (so are hedge funds, but that’s a different story altogether). They are seen as bridges to higher return on lower volatility and originators of upcoming hedge fund stars. For doing so, Funds of Funds charge a layer of fees that on the average are lower than the average 2%/20% fees charged by single hedge funds, and from years ago to possibly years ahead, investors will probably continue to invest with these Fund of Funds and continue to pay an additional layer of fees.
(photo: This is San Francisco by Sutanto / © All rights reserved)
Market players estimate that Funds of Funds manage about half of the assets invested in the alternative investments industry. According to Lipper, retail funds of funds that pick from the whole hedge funds market returned an average of over 10% over one year to October 31 2007. Hedge Fund Research (HFR) estimated the average performance of hedge funds to be a little more than 10% for the same year. An investor worth his weight never leaves out the risk (or volatility) when considering an investment, but since both Lipper and HFR chose to leave the average volatility these hedge funds and Funds of hedge Funds went through for the year, I will assume that they are similar – for the sake of completing this post. Taking these numbers with a pinch of salt, I find it difficult to justify paying additional fees to the Fund of Funds manager if performance was the primary pitch for Fund of Funds.
Investors in Funds of Funds also hope that their managers are at the root of the grapevine, listening in on every conversation and idea in the industry to try and spot the next performing fund. As originators, Funds of Funds managers spend most of their time at conferences, seminars, networking events and meetings in order to keep abreast of the latest trends in the hedge fund market. With the explosive growth of the internet, cost-conscious Funds of Funds are beginning to replace such on-the-ground research with subscriptions to hedge fund databases (HFR, HF.net, etc) and news sources (Opalesque, EurekaHedge, etc). Instead of attending meetings in person, Funds of Funds are also beginning to save operations costs by making Skype calls. The maximum trading frequency of a Fund of Funds? Once a month.
Dow Jones recently reported (link) that the proportion of U.S. pension assets overseen by Funds of Funds fell to 49% on September 30 from 57% in 2002. It states that the shift away from investing through Funds of Funds reflects an increasing confidence among institutional investors in choosing their own hedge fund investments. Could this be the real reason? Were institutional investors never confident in choosing their own hedge fund investments before this data was published? Probably, but possibly not. It seems to me that the re-emergence of the Internet as a tool for data sharing and collaboration is starting to empower investors more than before. Funds of Funds used to be a bridge to industry information, now that bridge is starting to be substituted by another – Internet 2.0.
Evolution is never selective. Hence, as this alternative investment industry grows into what we can only imagine today, Funds of Funds must also evolve and change.
I would love to hear some comments on these thoughts of mine.
Felix.
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