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Part IV. Fund of Hedge Funds

BLOG, EDUCATION  |  5 May 2010

There is yet another way that investors can access the “alternative” strategies that traditionally have only been available through hedge funds. This is the creature known as the “fund of hedge funds” (FOHF), which is simply a fund that invests its assets in two or more hedge funds. Some FOHFs register with the SEC, and some do not. The ones that do register are required to furnish a prospectus and file quarterly reports. Registered FOHFs often have fairly low initial investment requirements, typically around $25,000. The idea behind a FOFH is to diversify the risk inherent in owning a single hedge fund by creating a portfolio, or fund, of hedge funds. This diversification comes with a cost because there is an additional layer of fees built in. On top of the management fees that are paid to the individual hedge funds (1 – 2% of assets plus a portion of the profits), the FOHF charges a fee for its efforts in researching, vetting, selecting, and monitoring the hedge funds it holds. Plus, some FOHFs also tack on their own performance fee based on the funds’ profits. Want some more fees with that? If you own a FOHF through your investment advisor who charges a percentage of assets under management, you have yet another level of fees. There’s no question that these things are a little pricy, but they do offer access to some effective strategies that before were only available to the wealthiest investors. No doubt this has contributed to their popularity. A 2005 article in The Wall Street Journal reported that FOHFs accounted for nearly 30% of all hedge fund assets. So, unlike the “hedge-like mutual funds” discussed in Part III, investors in FOHFs are participating in real hedge funds, not just light versions of hedge fund strategies.