FIN-02-031 |
NYU Stern School of Business |
September 2002
Stephen J. Brown, William N. Goetzmann and Bing Liang
ABSTRACT
Abstract: Funds of funds are an increasingly popular avenue for hedge fund investment. Despite the
increasing interest in hedge funds as an alternative asset class, the high degree of fund specific risk
and the lack of transparency may give fiduciaries pause. In addition, many of the most attractive
hedge funds are closed to new investment. Funds of funds resolve these issues by providing
investors with diversification across manager styles and professional oversight of fund operations
that can provide the necessary degree of due diligence. In addition, many such funds hold shares in
hedge funds otherwise closed to new investment allowing smaller investors access to the most
sought-after managers. However, the diversification, oversight and access comes at the cost of a
multiplication of the fees paid by the investor. It is not generally understood that the incentive fee
component of the fee on fee arrangement may under certain circumstances exceed the realized return
on the fund. In this paper we argue that the disappointing after fee performance of some fund of
funds may be explained by the nature of this fee arrangement. We examine an alternative fee
arrangement that may provide better incentives at a lower cost to investors in these funds.
Stephen J. Brown
Institution: Stern School of Business, New York University, 44th West 4th Street, New York, NY 10012
Telephone: 212-998-0306
Fax: 212-995-4233
Email: sbrown@stern.nyu.edu
Homepage: http://www.stern.nyu.edu/~sbrown/
William N. Goetzmann,
Institution: Yale School of Management, Box 208200, 135 Prospect Street, New Haven CT 06520-8200
Telephone: 203-432-5950
Fax: 203-432-8931
Email: william.goetzmann@yale.edu
Bing Liang
Institution: Case Western Reserve University, 10900 Euclid Ave, Cleveland, OH 44106-7235
Telephone: 216-368-5003
Fax: 216-368-4776
Email: bxl4@po.cwru.edu
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