Hedge Fund of Funds Investing An Investor's Guide

by Nicholas, Joseph G.

• ISBN13: 9781576601242
• ISBN10: 1576601242
• Edition: 1st
• Format: Hardcover
• Copyright: 2004-01-01
• Publisher: Bloomberg Press

Summary

Hedge funds have rightly gained the attention of private and institutional investors in recent years, proving themselves as useful portfolio diversifiers and preservers of wealth while greatly dispelling their reputation as an "unsafe" investment. Yet investors attempting to navigate in the field of hedge funds face significant challenges: the large number of funds, the diversity of strategies used, the range of financial instruments traded, and the various formats for investing. Pooling multiple hedge funds together into one vehicle, the fund of funds provides a ready solution, combining professional management expertise with asset allocation. In this book--the first of its kind--industry expert Joseph Nicholas shows investors how these funds operate, the benefits and risks, and the criteria and due diligence to utilize when selecting funds. Nicholas provides an in-depth analysis of historical fund performance and offers unique insight into the industry and trends that may affect its evolution. Clear, insightful, and illustrated with numerous charts and graphs, Hedge Fund of Funds Investing is an essential resource for serious investors.

Author Biography

Joseph G. Nicholas, JD, is founder and chairman of HFR Group, LLC, which includes HFR Asset Management, LLC, a fund-of-funds management company, HFR Europe, Ltd, an investment advisory firm, and Hedge Fund Research, Inc., a leading supplier of hedge fund data. Author of Investing in Hedge Funds and Market-Neutral Investing, he is a frequent lecturer and media expert on topics relating to alternative investments.

Table of Contents

Acknowledgments	xiii
Introduction	xv
Part 1 THE FUND OF FUNDS INDUSTRY
1 Fund of Funds in the Hedge Fund Industry	3	(20)
Hedge Fund Investment Options	4	(2)
Direct Investment	5	(1)
Customized Portfolio	5	(1)
Index Fund	6	(1)
Fund of Funds Investment	6	(1)
Growth of Funds of Funds	6	(5)
Hedge Fund Industry Characteristics and Trends	11	(3)
Hedge Fund Investment Structure	14	(7)
Legal Structure	16	(1)
Numbers of Investors and Minimum Investment Size	17	(2)
Reporting and Disclosure	19	(1)
Liquidity	19	(2)
Lockup	21	(1)
Summary	21	(2)
2 Hedge Fund Investment Strategies	23	(26)
Convertible Arbitrage	27	(1)
Distressed Securities	28	(2)
Emerging Markets	30	(1)
Equity Hedge	31	(2)
Equity Market Neutral	33	(2)
Event Driven	35	(2)
Fixed Income	37	(2)
Macro	39	(1)
Market Timing	40	(1)
Merger Arbitrage	41	(2)
Relative Value Arbitrage	43	(1)
Sector Long/Short	44	(1)
Short Selling/Short Bias	45	(2)
Summary	47	(2)
3 Fund of Funds Mechanics and the Two-Tiered Structure	49	(16)
Structural Considerations	51	(13)
Organization Structure	51	(1)
Company Structure	51	(1)
Domicile	52	(1)
Subscriptions and Registration Exemptions	53	(1)
Minimum Investment Size	53	(2)
Fees	55	(2)
Lockup, Redemption, and Liquidity	57	(3)
The Fund of Funds Management Company	60	(1)
Manager Due Diligence and Selection	61	(1)
Risk Management	62	(1)
Operations	62	(1)
Performance and Exposure Reporting	63	(1)
Summary	64	(1)
4 Advantages and Disadvantages of Funds of Funds	65	(16)
Advantages	66	(9)
Diversification	66	(1)
Due Diligence	67	(1)
Risk Management	68	(2)
Portfolio Management: Strategy Selection and Manager Selection	70	(2)
Access to Funds/Capacity	72	(1)
Consolidated Reporting	73	(1)
Fees	74	(1)
Performance	74	(1)
Disadvantages	75	(2)
Exposure to Other Investors' Cash Flows	75	(1)
Fees	75	(1)
Lack of Control/Customization	76	(1)
Decreased Transparency	76	(1)
Summary	77	(4)
Part 2 HISTORICAL PERFORMANCE OF FUNDS OF FUNDS
5 Performance of Funds of Funds	81	(26)
Fund of Funds Substrategien	84	(3)
HFRI Fund of Funds Conservative Index	84	(1)
HFRI Fund of Funds Strategic Index	85	(1)
HFRI Fund of Funds Diversified Index	85	(1)
HFRI Fund of Funds Market Defensive Index	86	(1)
Fund of Funds Returns 1990-2002	87	(3)
Fund of Funds Returns 2000-2002	88	(2)
Fund of Funds Volatility 1990-2 002	90	(3)
Fund of Funds Volatility 2000-2002	91	(2)
Fund of Funds Return Versus Volatility 1990-2002	93	(3)
Fund of Funds Risk-Adjusted Returns-The Sharpe Ratio	96	(4)
Sharpe Ratio 1990-2002	97	(2)
Sharpe Ratio 2000-2002	99	(1)
Preservation of Capital 1990-2002	100	(3)
Fund of Funds Performance Versus Equities	100	(1)
Fund of Funds Performance During Bear and Bull Markets	101	(2)
Average Performance During Negative Periods and Positive Periods 1990-2002	103	(2)
Return Distribution 1990-2002	103	(1)
Fund of Funds Performance During Periods of Market Stress	104	(1)
Summary	105	(2)
6 Fund of Funds in a Portfolio With Traditional Assets	107	(16)
Linear Analysis of Returns	107	(3)
Adding Funds of Funds to a Traditional Portfolio	110	(8)
Achieving Superior Risk-Adjusted Returns	118	(1)
Summary	118	(5)
Part 3 A COMMONSENSE APPROACH TO SELECTING FUNDS OF FUNDS
7 Defining Objectives and Identifying Candidates	123	(14)
Step 1: Define Objectives and Parameters	124	(3)
Objectives	124	(1)
Parameters	125	(1)
Strategy Restrictions	126	(1)
Structural Requirements	126	(2)
Fund of Funds Objectives and Parameters Worksheet	128
Step 2: Screen to Create a Funds of Funds Short List	127	(9)
HFRI Fund of Funds Conservative Index	130	(1)
HFRI Fund of Funds Strategic Index	130	(1)
HFRI Fund of Funds Diversified Index	131	(1)
HFRI Fund of Funds Market Defensive Index	131	(5)
Summary	136	(1)
8 Issues in Due Diligence: The Fund of Funds Firm	137	(18)
Background Information	138	(9)
Staff Information	138	(2)
Company Structure	140	(1)
Asset Management Activities	141	(6)
Product Information	147	(4)
Performance	151	(2)
Summary	153	(2)
9 Issues in Due Diligence: Portfolio Management	155	(16)
Asset Allocation/Style Selection	156	(4)
Due Diligence Criteria in Manager Selection	160	(4)
Portfolio Construction	164	(6)
Summary	170	(1)
10 Issues in Due Diligence: Risk Management	171	(16)
IV Transparency and Separately Managed Accounts	172	(6)
Transparency	172	(3)
Managed Account Structures	175	(1)
Pricing Risk Case Study: Lipper	176	(1)
Style Drift Case Study: Integral	177	(1)
Risk Management	178	(5)
Compliance and Legal Issues	183	(3)
Summary	186	(1)
11 Fund of Funds Selection Case Study	187	(10)
Scenario	187	(8)
Step 1: Defining Investment Objectives and Parameters	188	(1)
Step 2: Screening to Create the Funds of Funds Short List	189	(1)
Step 3: Conducting a Due Diligence Screen of the Funds of Funds Short List	189	(1)
Step 4: Evaluating Finalists for Selection	190	(5)
Final Selections	195	(1)
Summary	196	(1)
Appendix A: AIMA Due Diligence Questionnaire	197	(10)
Appendix B: Excerpts from HFR Fund of Funds Industry Report	207	(46)
Index	253