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Do funds-of-funds deserve their fees-on-fees?

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Do funds-of-funds deserve their fees-on-fees?

1 Introduction

The working paper, authored by Andrew Ang, Matthew Rhodes-Kropf and Rui Zhao, discuss whether fund-of-funds deserve their fees-on-fees. Since the after-fee returns of funds-of-funds are lower than hedge fund returns, it is easy to deduce that funds-of-funds do not add value compared to hedge funds.

2 Benchmarking Funds-of-Funds
2.1 Hedge Fund and Fund-of-Funds Returns
The authors conclude that funds-of-funds do not add much value relative to hedge funds.
2.2 The True Fund-of-Funds Benchmark
The authors discuss the true fund-of-funds benchmark.
2.3 Constructing the True Fund-of-Funds Benchmark
The authors consider rather the fund-of-funds benchmark to be the set of hedge funds that an investor could invest in on her own without recourse to funds-of-funds.

3 Methodology
3.1 The Portfolio Allocation Problem
The authors describe how a standard portfolio allocation framework can deduce the characteristics of the benchmark fund-of-funds distribution.
3.2 Benchmark Assets and Moments
Select sets of benchmark assets are used, while moments for hedge funds and funds-of-funds are computed.

4 The Fund-of-Funds Benchmark
The authors present empirical results evaluating the performance added of funds-of-funds relative to hedge funds.

5 Robustness
The authors find that the results are robust to alternative ways of computing expected returns and volatilities.

6 Conclusion
Funds-of-funds charge comparatively large fees-on-fees which are paid in addition to the fees charged by the underlying hedge funds. The after-fee alphas and average returns of funds-of-funds are lower than the after-fee alphas and average returns of hedge funds. The authors deem that funds-of-funds should not be evaluated relative to hedge fund returns in publicly reported databases. Instead, the correct fund-of-funds benchmark is the set of direct hedge fund investments an investor could achieve on her own without recourse to funds-of-funds. They employ asset allocation concepts to estimate characteristics of the fund-of-funds benchmark distribution.

References

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=687274

 

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