Hedge Fund-of-Funds a Good Bet for Many Investors

April 24, 2008 (PLANSPONSOR.com) - A new research study suggests the ability offered by hedge fund of funds for individual investors to access hedge fund strategies "provides value to less skilled investors."

The study, prepared for the National Bureau of Economic Research (NBER), suggests the hedge fund of funds vehicle may well be a viable investing alternative for the individual investor because of the access to hedge funds it offers. In their report, “Do Funds-Of-Funds Deserve Their Fees-On-Fees?” authors Andrew Ang, Matthew Rhodes-Kropf, and Rui Zhao assert that investors considering a hedge fund of funds should judge its performance against the net of fees performance of other hedge funds to which the investor would have access and not the hedge fund industry as a whole.

Based on their asset allocation analysis underlying a fund of funds benchmark, the study concludes: “funds-of-funds, on average, deserve their fees-on-fees.”

“We find that it is not hard to justify the use of a fund-of-funds and the conditions under which investors choose a fund of funds over hedge funds are economically reasonable and plausible,” the authors contend. “An investor with no skill in locating and monitoring hedge funds would, on average, choose hedge funds that are worse than the typical hedge fund observed in data, if she were forced to directly invest in hedge funds without using a fund-of-funds intermediary.”

The authors assert that the return rate which an individual investor would have to generate on his own to justify a decision not to go the fund-of-funds route is close to a typical return of a TASS database hedge fund. So, the study contends, if investors think they would lag that figure by a small amount investing on their own or if their costs of direct hedge fund investing are larger than the difference between the TASS fund benchmark return and their expected return, then a fund of funds is the way to go.

The report continues: “The existence of the fund-of-funds industry helps investors gain access to a better skill set of finding, evaluating, selecting, and monitoring hedge funds. For investors with relatively little skill or small investment amounts, funds of funds add value, even if their after-fee returns are lower than the returns of hedge funds. “

The study report is available by subscription at http://www.nber.org/papers/w13944 .