Funds of hedge funds (FOHFs) are investment funds that invest in a diversified portfolio of hedge funds and sell shares to a broader range of investors than qualify to buy hedge funds directly. And there are no limits on the number of investors that a fund may have. They may or may not be registered with the
Securities and Exchange Commission (SEC).
You don't have to be an accredited investor, though you must meet certain net worth criteria.
Pros and cons
One attraction of investing in a FOHF is that you have effectively hired a manager to take responsibility for researching, building, and monitoring a portfolio of hedge funds, which can be a daunting task for an individual investor. Further, buying FOHF shares requires a smaller financial commitment. The minimum required investment is typically closer to $25,000 than to the $250,000 to $1 million minimum for an individual hedge fund.
A fund of funds also offers:
Access to hedge fund managers otherwise unavailable because their funds are closed to new investors
A diversified portfolio of hedge funds, which may reduce risk and smooth out returns
One disadvantage of investing in FOHFs is that they impose a layer of management and performance fees over and above the fees imposed by the hedge funds they invest in. FOHF fees typically charge 1% to 2% of assets under management and a 5% to 10% performance incentive fee on top of the already substantial hedge funds' management and performance fees.
Another limitation is that an FOHF is not required to redeem shares if you want to sell, though some funds do. And since most of these funds aren't listed on an exchange, there's no secondary market.
However, the proliferation of FOHFs seems to indicate that for many investors these drawbacks aren't a sufficient disincentive, perhaps because in their minds the advantages of hedge fund exposure outweigh the extra cost and illiquidity.
