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FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

A pension plan allocates to a fund of hedge funds (FoHF) rather than investing directly in single managers. Which of the following is a recognized drawback of the FoHF structure compared with direct investment?

The key drawback of a fund of hedge funds is the double layer of fees: investors pay the FoHF's own fees plus the management and performance fees of each underlying fund. Diversification, access and delegated due diligence are benefits of the structure, not drawbacks.

  1. AReduced diversification across strategies and managers
  2. BDouble layer of fees, as investors pay both the FoHF fee and the underlying managers' feesCorrect
  3. CInability to access managers who are closed to direct investors
  4. DLoss of the FoHF manager's operational due diligence on underlying funds

Explanation

A FoHF charges its own management and often performance fee on top of the fees charged by each underlying hedge fund, which drags net returns. The other options describe benefits of FoHFs: diversification, access to capacity-constrained managers, and delegated due diligence.

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