As the name suggests, a "Fund of funds" is a fee-based investment vehicle whose target is not individual stocks, bonds, or other instruments, but other hedge funds.
The two largest benefits to investing in a fund of funds are that they tend to have lower capital requirements (making them more accessible to the retail investor) and handle the extensive due diligence work that an investor would have to do if they chose to invest in hedge funds on their own.
But there's a catch: in addition to the usual management and incentive fees by the underlying hedge funds in the portfolio, funds of funds charge an additional fee on top of it (usually 1% of assets and 10% of profits). This effectively means that if you invest in one of these vehicles, you're being charged a double layer of fees, which obviously has a negative impact on overall performance.
If you're interested in finding out more about funds of funds, how they work, and their role in the marketplace, "Hedge Fund of Funds Investing" by Joseph Nicholas is for you.
In a relatively short read (just under 200 pages), he gives an extensive overview of these instruments and how they can augment a traditional portfolio.
A lot of time is spent on the due diligence process for selecting one of these funds of funds, which is both valuable and useful. Probably the most important piece of this work is the final chapter, which pulls all of the concepts together in a case study that takes you through the screening, short list, onsite visits, and all the other tire-kicking that investors are supposed to do before making a final selection. Hint: it's not as simple as "just choose the one with the lowest fees and the highest performance."
There is also an extensive amount of charts and performance numbers broken out by strategy for all of you stat monkeys out there. To be blunt, at a high level, average fund of funds performance is not very impressive, and the main reason is that double layer of fees. Although a bit more stable and consistent than the broaderdue to the benefits of diversification, over the long term fund of funds have actually underperformed the rest of the industry. But as a whole has been around for such a relatively short time that some would argue those numbers don't really mean much.
Regardless, the reason you'd invest in one of these is that same risk-return tradeoff that you would consider for any other investment: if you believe that the return is acceptable for the fees and the risk, you can potentially find a winner. And this book helps you find what to look for if you're interested in funds of funds.
Read up, monkeys!
Monkey's Review 1: Barbarians At the Gate
Monkey's Review 2: The Financier
Monkey's Review 3: Decision Points
Monkey's Review 4: Debunkery
Monkey's Review 5: When Genius Failed
Monkey's Review 6: Monkey Business
Monkey's Review 7: Death Of The Banker
Monkey's Review 8: A Journey
Monkey's Review 9: Damn It Feels Good To Be A Banker
Monkey's Review 10: The Quants
Monkey's Review 11: All About Hedge Funds
Monkey's Review 12: The Unlikely Disciple
Monkey's Review 13: Adventure Capitalist
Monkey's Review 14: The Hedge Fund Book
Monkey's Review 15: Investing In Hedge Fund of Funds
Monkey's Review 16: Hilarity Ensues
Monkey's Review 17: The Prince
Monkey's Review 18: Markets Never Forget (But People Do)
Monkey's Review 19: The Money Culture