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Explaining a Hedge Fund of Funds
A hedge fund of funds is an investment approach that builds a portfolio with funds, rather than directly investing in securities such as stocks or bonds. The strategy governing the portfolio can be similar to those of hedge funds, in that the strategies are often complex and attempt to capitalize on certain market trends or movements.
Hedge Fund of Funds-Multiple Funds that Fit an Overall Strategy
The fund of funds investment approach can be used for any variety of underlying investment schemes, from mutual funds to private equity funds to venture capital funds. These investments are also known as a multi-manager investment or a collective investment, because there are many different investment strategies layered into one portfolio. A hedge fund of funds can include any number of funds that fit into an overall strategy and structure that is actively managed by a professional money manager.
Hedge funds and hedge fund of funds are often regarded as complicated or high-risk investments relative to traditional investments, such as in stocks or bonds. This is partly because hedge funds have traditionally not needed to register with the Securities & Exchange Commission (SEC) and disclose public information about their investments, leading to a lack of transparency. New regulations, however, now require hedge funds of a certain size to register with the SEC and more information to be disclosed. Still, hedge funds typically have more liberty than the usual investments to conduct their trading and investing strategies.
Most of the underlying investments found in hedge funds are the same ones available to individual investors, but the strategies that are employed can include complex investment instruments, including the use of future, options, swaps, fixed income, leveraging, arbitrage, and distressed securities, among many others. Because the strategies can be quite complex and costly, many hedge funds require high minimums to invest or may be closed to individual investors. Instead, individual investors with fewer assets can invest in a hedge fund of funds, which pools investors’ assets together to invest in these otherwise inaccessible hedge funds.
Not only can a hedge fund of funds offer access to investors, it can also offer diversification benefits. A portfolio with many funds can increase stability and reduce risks compared to investing in singular funds or securities, although no investment is completely without risk. When selecting a hedge fund of funds, it is critical to find one with a capable manager as well as one that is aligned with your personal investment objectives. Investors should note that hedge funds can be unregistered, meaning they are not subject to the same regulatory requirements expected of equity or mutual funds. The typical shareholder protections can be absent, making it possible for a dishonest hedge fund manager to defraud investors. Thus, investors should make sure to conduct the proper due diligence and verify the legitimacy of the hedge fund of funds and its performance track records using multiple sources. Investors should ask to see a prospectus and make sure they understand all management and performance fees.
Investing in a hedge fund of funds can offer investors access to many different investment strategies. This can be quite appealing, especially if the strategies fit well within an investor’s portfolio and cannot otherwise be gained through traditional investments.
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