In these times of financial austerity, both on the parts of governments and individuals, it has been suggested that ‘Fund of Funds’ – private investment vehicles that invest exclusively in hedge funds, may be set for a decline in popularity.
The logic is fairly simple. Fund of Funds are effectively simply financial intermediaries who aim to make profit by attempting to aggregate gains from the hedge fund industry.
Unsurprisingly, such a strategy has reaped rich dividends over the last couple of decades, with the boom of financial services since the turn of the millennium proving particularly profitable.
The hedge fund industry as a whole has been touted to fold from its pre-crisis highs, given that they have been unable to satisfy their mandate – to make money no matter what the macroeconomic climate holds. This fact, combined with the requisite economies of scale necessary to keep a fund of fund profitable, may well herald a concentration of the market to just “four or five firms.”
However, such times seem to be limited for the time being. Where fund of funds allowed investors access into an exclusive ‘alpha-intensive’ arena, such an aura of exclusivity was shattered when the crisis hit, reducing most hedge funds to beta status in the eyes of most institutional investors.
Their margins were acceptable in times of growth, and investors were willing to pay higher fees than direct involvement because the industry as a whole was growing, and they wanted to be a part of it in whatever way possible. As this FT article outlines, “the average fund of funds charges 1 per cent of assets invested and 10 per cent of profits in addition to the 2 and 20 the managers it invests in charge.”
Consequently, we could be seeing a paradigm shift in the hedge fund industry. However, investor’s appetite for profits are limited only by the risk with which they can be purchased. As the ‘new normal’ economic model emerges after the political uncertainty resides across the developed world, as it eventually must, we will see a re-emergence of the hedge fund industry as a whole, and with it, derivative vehicles making money on the back of these funds.
Write funds of funds off at your peril.