how to start a fund of funds

Starting a fund-of-funds can be a very rewarding as well as challenging opportunity for financial entrepreneurs who want to start their own hedge fund. Instead of managing trades and evaluating different asset classes, the fund manager has the task of researching and choosing which hedge funds they wish to invest in based on various risk parameters.

A Fund-of-funds is a pooled investment vehicle where the fund’s investor’s capital is allocated to a predetermined number of other hedge funds with varying strategies.

Rather than selecting individual stocks and bonds to invest in or participating in riskier strategies like early-stage venture investing, growth equity, or late-stage buyouts – a fund-of-funds performs due diligence on active managers to invest in.

Most of the due diligence conducted by a fund-of-funds focuses on 4 areas: 

The Fund Manager, Asset Class Allocation, Sectors and Industries and trading strategy.

The primary objective for all fund-of-funds is to identify the right hedge funds to allocate capital in order to maximize returns while simultaneously managing the downside risk by spreading the capital across different hedge funds, strategies, sectors, and asset classes.

Hiring an experienced hedge fund consultant, like Frank Nagy Financial Services will greatly reduce the burden of setting up your fund-of-funds. A good consultant will provide advice on how to select the right hedge funds to invest in as well as make the appropriate introductions to fund administrators, auditors and attorney’s that will help your fund grow.

One of the main benefits for investors that invest in fund-of-funds is diversification, since the fund-of-funds risk in its portfolio is reduced by holding investments across a broad set of asset classes and investment strategies.

Since fund-of-funds invest in active managers, the fund has indirect exposure to not just one but several active fund managers. Many high performing hedge funds will often ignore inquiries from individual investors due to the small size of investment in the fund. 

But with a fund-of-fund, this process is bypassed since the fund can invest with a larger amount represented by multiple investors. In fact, individual and small institutional investors that might not meet the requirements to be a limited partner in certain profitable funds can be grouped together through the fund-of-funds.

Since capital is invested into active fund managers, there are 2 layers of fees:

Fees of the underlying hedge funds and -the fund-of-funds fees.

The standard fee structure for most hedge funds are 2% annual management fee and 20% performance fee or carried interest. This is known as the 2 and 20.

Due to the double fee structure, investors of a fund-of-funds can expect a lessor return on their investment compared to investing in separate hedge funds. 

Typically, a fund-of-fund manager can charge anywhere between 0.25% to 1.0% annual management fees, with performance fees ranging from 5.0% to 15.0% per year. The fund-of-funds fees is placed on top of the fees charged by the underlying hedge funds in its portfolio. 

Contact us to learn more about starting a Hedge fund of funds.