Comparing the Performance of Different Categories of Funds of Funds Hedge Funds in Terms of Fees, Monthly Returns and Risk Adjusted Measures

This article aims at testing empirically the major building blocks that affect the performance and risk adjusted measures of funds of funds hedge funds: incentive fees, management fees, size, age, hurdle rate, high watermark provision and lockup period. Funds of hedge funds invest solely in other hedge funds. The hedge fund manager selects funds based on a specific investment strategy or a combination of different investment strategies to achieve a better return. The benefit of combining different investment strategies is to achieve diversification and skilful management to reduce market risk. The disadvantages are the fees of asset management and the incentive fees that are charged to manage these funds. They charge a 2% fee and an incentive fee of 15% to 25% from the profit that is generated. The double fee structure is a disadvantage of investing in funds of funds. The risk is that you could loose from your initial capital due to low return and high transaction fees. Fund of funds cannot as easily be liquidated. They have a withdrawal period of either monthly or quarterly. As an example, we can mention large cap equity stocks that are traded in the S&P 500 index in the USA and government bonds. The equity benchmark rate was either the S&P 500 or MSCI World while the government bonds benchmark rate is the Citigroup world government bond index, WGBI. Different funds of funds have different objectives and as a result different level of volatilities. Therefore, a diversified portfolio with negative correlations between various investment products reduces the level of market - beta risk and manager risk. Beta and alpha measures are compared to show the skilful capability of the hedge fund manager. Funds with monthly returns of five years showed an annual standard deviation of volatility equal to 50% whereas the lowest rate was 15%. The sample is provided from Data Feeder dataset. It is very comprehensive and includes funds of funds hedge funds for the period 1998 to 2003. There are other factors that could contribute to performance persistence such as lock-up periods, hurdle rate and high water mark.