Diversification Benefits of Private Equity Funds-of-Funds

The double layer of fees in funds-of-funds is controversial, especially during periods of high economic performance in which the extra fees can be large. This chapter takes an investor’s view when examining the conditions in which an investment in funds-of-funds pays off despite the fees-on-fees. The chapter considers an investor’s degree of risk aversion and applies a certainty equivalent level of final wealth. Thus, determining whether the benefits outweigh the additional costs requires knowledge of the investor’s degree of risk aversion. This chapter shows that funds-of-funds substantially reduce the risk of private equity (PE) investments through diversification especially if management adds value by carefully selecting the underlying funds leading to a higher acceptance of fees.