'Me too' funds are less common in the hedge fund world, but they do exist. The experience of the fun...
'Me too' funds are less common in the hedge fund world, but they do exist. The experience of the fund of funds manager is a key consideration because often the underlying funds are obscure and unknown to the average investor. Getting details on all holdings is nigh on impossible, because revealing such data could be detrimental to overall performance. While the sector is still relatively young, there are FoHF managers with experience of the $4.6bn collapse of Long Term Capital Management in 1998. This was an important lesson for managers and reinforced the need for risk control and a diversified range of underlying strategies. More recently, some hedge funds suffered, albeit far less than their long-only counterparts, through over-reliance on equity-driven performance.
What are fund of hedge funds good for? Just about anything, depending on the underlying strategies employed, risk profile of the fund, volatility and needs of the investor. Global long/short funds are a partway replacement for standard equity portions of an investor's portfolio, tending to give up some of the upside for the protection offered by shorting stocks should markets fall. Arbitrage strategies are more dominant for income seekers, sitting with the fixed interest portion of a portfolio.
Cost of protection There is a cost to seeking absolute returns and the derivative instruments used are not free of charge. They themselves cost money and hedge fund fees are higher than for ordinary funds, leading to extremely healthy incomes for hedge fund managers if they get their investment strategies right. Advisers argue that a truly diversified and well run FoHF should not have to employ large amounts of protection strategies for its investments.
Listing Most hedge funds are listed offshore, mainly on recognised exchanges and domiciled in appropriate countries - the Channel Islands, Bermuda and other tax favourable territories. The funds also generally have distributor status and are therefore taxed to income, which causes a tax liability for most investors, unless they use Sipps or bond wrappers. In a bid to open up the retail market, some funds are listed in the UK using structures to make them chargeable to capital gains tax.
Open or closed end The majority of FoHFs are open ended but closed-ended funds are popular too. Open-ended fund investors must pay special attention to dealing dates because redemptions are usually monthly, quarterly and sometimes even less frequent. Closed-ended funds work just as with ordinary investment trusts. Supply and demand will have a greater impact on the price of each share and broker costs need to be considered. Occasionally, closed-ended funds offer a buyback market for shares, allowing investors to concentrate on underlying performance and net asset value rather than share price premiums or discounts.
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