Instant Diversification: Funds of Funds

This chapter explains that the growth in funds of funds reflects an increasing number of both institutional investors and individuals who were not previously hedge fund investors, but have now decided to gain access to hedge funds through diversified portfolios provided by funds of funds. Funds of funds provide valuable services that many investors interested in investing with hedge funds would find hard to obtain: access to top hedge funds and diversification. For these services, funds of funds exact a price in the form of additional fees, reduced liquidity, and little transparency in terms of the hedge funds in their portfolios. However, there is scant evidence that the average fund of funds generates alpha or delivers the full range of services promised to investors, from access to difficult-to-access hedge funds to effective risk management.