Beware Of The Massive Fees On Hedge Fund Of Funds - Investors Are Being Used
August 2006
Sadly many people these days are insecure enough that they feel the need to brag to their friends and/or strangers about their wealth, car, property or investments etc. But when it comes to investments no two words get the kind of sparkling reaction that these two do - Hedge Funds, as in 'I'm an investor in some Hedge Funds'.
Hedge Funds seem to give a hypnotic feeling over many people. They think that’s where the action and real money is. Have you noticed for example in the papers you’ll always see quotes of ‘hedge fund managers’ when it comes to spending money or in articles about the flashiest of holiday destinations.
But sadly (for many investors) like in any industry there’s the pyramid effect at work. Only a few top dogs at the tiny summit and then many many lacklustre wannabees heading down to the large base.
However, even the Hedge Funds that aren’t performing can actually be spectacular investments for those who are behind them, the partners and/or original investors. The reason for this is simple, making money for their clients has for most of the funds ALWAYS come secondary to making money for themselves.
Or to put it another way, the fund managers always get paid before the investors regardless of whether the fund actually makes money or not.
And nowhere is this phenomenon better highlighted than with Hedge Fund of Funds (FoF).
Fund Of Funds - Why They Generally Stink
A Fund of Fund (FoF) is like an umbrella fund, it doesn’t actually do any investing itself, rather it invests in individual Hedge Funds. The likely marketing spin of FoFs always says such things as a FoF will 'reduce volatility’ or to ‘use our skill and experience in seeking out the best Hedge Fund talent in the market’.
In reality though a Fund of Funds is basically there to rake in fees and as you can see below it’s pretty obvious who gets the better end of the deal, the fund management company or the investor.
- In the last month a large fund management firm has been promoting the following Fund of Funds (we’d like to name names but will only be forced when contacted by their lawyers to pull this article)
- This Hedge Fund of Funds charges investors a annual management fee of 1.25% plus a 5% performance fee (the fund takes 5% of any gains, if no gains then no performance fee)
- The FoF will then invest in Hedge Funds which themselves charge an average of a 2% annual management fee and a 20% performance fee
- The fund is looking for a target return of around 12% a year AFTER fees which means they’ll have to look to invest in Hedge Funds consistently returning 20% a year (before fees). But then isn’t EVERYONE in the world looking for these kind of returns....
- The 20% returns look awfully optimistic when the CSFB/Tremont Hedge Fund Index has historically returned around 8%+ after fees
In our view there’s a better than 95% chance that investors won’t get anything like the 12% target returns, instead with all the fees and fees on fees the overall fund is likely to under-perform the CSFB/Tremont Hedge Fund Index.
Summary
High fees are the death of all investors but high fees is exactly what you get with Fund of Funds. Hopefully you can now see why -
a) salaries are generally so high in the financial markets (because they’re experts at not only charging high fees but getting away with it), and
b) why Fund of Funds should generally be avoided unless you really do your due diligence and homework into exactly what and who you’re investing in/with
If you're interested in this topic then we highly recommend you read an excellent piece that appeared in the Economist in Feb 2005 entitled The New Money Men (opens in PDF format)
See Also
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