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Alternative Market Briefing

Other Voices: Not your father’s fund of hedge funds

Thursday, August 04, 2011

By Michael Bernstein, CFA, CAIA

If you ask ten funds of hedge fund (“FOHF”) managers to state whether they generate more of their returns from manager selection or strategy allocation, a couple of things will happen. The first is that all 10 will tell you it is very difficult to quantify how much comes from one vs. the other. This is true, but when hard pressed (i.e., when forced to fill out an RFP for a $250m mandate) most will cough up an answer. And that answer, in the overwhelming majority of cases, is that at least 2/3 of their return comes from manager selection, with strategy selection accounting for no more than 1/3.

Why is this the case? After all, don’t FOHF managers spend their days speaking with a huge range of hedge fund managers, arguably the most opinionated and talented investment professionals on the planet? Surely, in the course of their day-to-day interactions with these hedge fund managers, the FOHF managers must formulate some of their own opinions about the direction of the markets, don’t they?

The answer is, of course, yes. It would be a particularly weak-kneed FOHF manager that didn’t have a view on markets after conducting a round of monthly updates with the managers in his portfolio. The interesting question is, in select cases, how the FOHF manager utilizes this view or, in the majority of cases, why he does little to nothing with it.

There are a number of scenarios to consider.

The first is the FOHF manager who, as a ......................

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