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CFA Level I · CFA Level I Exam · Alternative Investment Performance and Returns

A fund-of-funds charges a 1% management fee and the underlying hedge funds charge 2% and 20%. This double layer of fees is most likely a disadvantage for investors mainly because:

The main disadvantage is the layered fees that reduce net returns. Underlying managers collect incentive fees on winning funds even when losing funds make the overall portfolio perform poorly, and the fund-of-funds manager adds another fee on top.

  1. Ait makes the returns of hedge funds less diversified
  2. Bfees at both levels reduce net returns, and incentive fees at fund level are paid even if the overall portfolio performs poorlyCorrect
  3. Cit requires investors to hold only one underlying fund

Explanation

Investors pay the fund-of-funds fee plus the underlying fees. Incentive fees are paid on winning underlying funds even if losses elsewhere leave the total portfolio flat or negative, creating a drag. Fund-of-funds typically increase diversification, not reduce it, and they hold many funds.

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