Allocation sizing for FoF structure
Individual investors
Allocation < $50mm
Considering fees and due diligence
Four Functions of FoF Management
Strategy and manager selection
Portfolio construction
Risk management and monitoring
Manager due diligence
Benefit Types of FoFs
Portfolio Benefits
Cost & Scale Advantages
Institutional Edges
—> Total: 11 benefits
FoF Benefits: Portfolio Benefits
Diversification
Liquidity
Currency hedging
Leverage
FoF Benefits: Cost & Scale Advantages
Economies of scale
Negotiated fees
Accessibility
FoF Benefits: Institutional Edge
Information advantage
Access to certain managers
Regulation
Education
Disadvantage Types of FoFs
Costs & Taxes
Governance & Information
-> Total: 6 disadvantages
FoF Disadvantages: Costs & Taxes
Double layer of fees
Performance fees not netted
Taxation
FoF Disadvantages: Governance & Information
Lack of transparency
Lack of control
Exposure to other LP’s cash flows
Three Ways for FoF Managers to Add Value
Long-term strategic style allocation (Beta)
Short-term tactical style allocation (Alpha)
Individual manager selection (Alpha)
Benefits of PE FoFs vs. In-House Program
Expertise in fund selection
Diversification (lower capital commitments & spread costs)
Access to LPs and liquidity management
Proper Management Incentives
Costs of PE FoFs vs. In-House Program
Second layer of management fees
Relationships with GPs remain with FoF
Less transparency and control
Lack of liquidity in FoF units
PE FoFs Investment Considerations
Investment Objective
Geography, style (VC/buyout), level of diversification
Type of FoF
Primary vs. secondary
PE FoFs Investment Process
Portfolio Construction (top down; strategic weights)
Manager and fund selection (bottom up; to build up to strategic weights)
Monitoring
Factors Driving PE FoF Market
Easy access for new, smaller PE investors
Complement to LP funds / directs
Operational & regulatory complexities
PE FoF Historical Performance
PE FoFs offer diversification by reducing performance dispersion vs. single PE funds
PE FoFs outperform public markets
Buyout FoFs underperform individual buyout funds
VC FoFs perform on par with individual VC funds
Diversification in Hedge Funds
Well diversified portfolio: 15-20 HFs
Theory: S / Wurzel (N)
S = SD of funds
N = number of funds
Empirical Evidence on FoHF
FoHFs underperform broad hedge fund indices
Reasons that FoHFs may be less biased than indices
Inaccurate index performance (survivorship bias / history bias)
Fund of Funds use realistic investment weights, not theoretical
What are Liquid Hedge Fund Alternatives
Investment strategy seeking HF exposures but offered in regulated, liquid vehicles
Greater transparency, liquidity and investor protection
Governing Liquid Hedge Fund Alternatives Regulations
UCITS (Europe)
‘40 Act (U.S.)
Regulations Coverage
Reporting
Key UCITS Regulations
Reporting frequency: 2 weeks
Leverage: 200%
Strict holding and concentrations
UCITS Holding Limits
35% European sovereign
20% investment fund
10% illiquid holdings
20% deposit at single institution
Max position: 10% (20% with derivatives)
Key ‘40 Act Regulations
Liquidity within 7 days
Symmetric performance fees
Min. 300% asset coverage for borrowing —> borrowing limited to 33% of assets
‘40 Act Holding Limits
Apply to 75% of the fund:
Max 5% in a single security
Max 25% in one industry
15% maximum illiquid holdings
Max 10% ownership of any single issuer
Strategies available in Liquid Alternative Funds
Macro and managed futures
Long/short equity
Equity market neutral
Relative value strategies
Multi-alternative Structures in Liquid Alternatives
Combine sub-funds / sleeves
Bypass leverage / concentration limits at fund level
Lower risk -> slightly lower / equivalent returns to HFs
Last changed9 hours ago