Zenith Investment Partners' Daniel Liptak examined the widely debated theory that funds of hedge funds are dead in this month's issue of their alternatives newsletter. Starting from a piece in the March issue of InvestHedge by Greg Fedorinchik of Mesirow, Liptak reports that the article looked at the cost of accessing hedge funds through four approaches: Investment in a commingled FoHF; Investment in a single investment fund (fund of one) managed by an external expert; Direct investment in hedge funds with the help of a generalist consultant; Direct investment in hedge funds with the help of a specialist hedge fund consultant.
Liptak reports that the costs required to invest directly in hedge funds are those that an indirect approach can reduce. Principally, these costs are the level of service provided by the consultant, the cost of internal staff to execute and monitor the investments. For Fofs, the key costs are considered the management fee and the type of structure - commingled or fund of one. And importantly, the scale of the Fof in negotiating fees with underlying managers.
Fedorinchik argues that the fee negotiating ability of a Fof can result in meaningful cost reductions in the form of better terms with the underlying managers, which often includes lower management and performance fees as well as use of incentive fee hurdle rates. These reductions are usually not available to small direct investors.
Liptak found that for a smaller allocation a Fof can offer the cheapest access point and that even for a larger investment there is not a huge difference between investing through a Fof or directly into a hedge fund. "There are of course risks that this analysis does not consider" Liptak writes. These risks include:
Complexity and implementation risk. The added complexity of hedge fund investing can create additional burden on back and middle office of the investor.
Implementation time, a direct program will take longer to implement than a turnkey Fof.
Switching and unwinding will be longer in a direct approach.
However, Fofs offer indirect benefits, which include:
Research and depth of coverage. Large Fofs and specialist advisors typically have teams scattered around the world and therefore should be in the front line when new information is released about a manager or strategy. An in-house team typically is less well-resourced with smaller data and operational support.
Live track record is readily available for a Fof, but not so for a new internal team.
Access to closed or unique managers, Fofs often have long term relationships with such funds and may have capacity agreements in place.
Customisation and service evolution. Investors need to understand which partner or program has the deepest knowledge and ability to customize portfolios as needs change.
Liptak concludes that there is very little difference between the cost of a Fof and investing directly. The issue of the double layer of fees may not be the whole picture given the savings from negotiating fees coupled with some of the benefits listed above.
(This piece first appeared in Opalesque, May 13th.)
This article was published in Opalesque's Asia Pacific Intelligence our monthly research update on alternative investments in the Asia-Pacific region.