21 - An overview of funds of hedge funds

Abstract

With substantial cash flows into the fund of funds business and questions as to their tax status, it is reasonable to ask whether it still makes sense to consider investing in funds of funds, particularly because the knowledge of the so-called hedge fund industry is growing and because it is becoming fashionable to argue that one can build one's own hedge fund portfolio. This chapter looks at funds of funds, with three principal areas of focus. First, it argues that there is a need for funds of funds for a number of wealthy, though not ultra-wealthy, individuals, for whom the alternative involving creating a portfolio of individual funds is not realistic. Secondly, it considers the three potential conceptual approaches to constructing a successful portfolio of hedge funds or of funds of funds and suggests that only one of these approaches would be available to all but the largest investors. Thirdly, it reviews the so-called fund of funds universe and point to important problems for the indices being used to track it, although significant improvements have been made in the recent past.