Alternative Investments: Hedge Funds

To help circumvent the pitfalls for investors of the single manager approach, intermediaries, such as banks and fund management companies, offer products known as multi-manager programmes or fund of funds.

The term multi-manager programme refers to any product where the investment pool is allocated to different hedge fund managers - creating a portfolio of hedge funds. Fund of funds are more specifically structured as limited liability investment companies, investment trusts or partnerships. Investors can buy and sell shares in these companies which, in turn, invest in a portfolio of hedge funds.

By extension, the term multi-manager programme is usually reserved for products that are tailored for an individual investor, or institution. These consequently require a much higher level of investment capital.

The aim of these structures is to offer investors access to an optimized portfolio of hedge funds at a reasonable cost. These products may be structured to provide investors with a well-diversified portfolio that invests in a wide variety of different types of hedge fund strategy and with a broad geographical basis. Or, they may invest in one strategy, but put together a portfolio of different hedge funds that all use that particular strategy to improve the overall risk-adjusted return.

The well-diversified hedge fund products are most suitable for investors who want to include a single alternative investment product into a traditional portfolio. It is important to recognise that the argument here is one of diversification, rather than hedging specific portfolio risks, as this has an impact on what the investor can expect from the product. Meanwhile, the single-strategy products are suitable for investors who have particular strategy preferences, or want to hedge specific portfolio risks.

In both cases, multi-manager advisors act as a buffer between the investor and the hedge funds. The advisors perform due diligence and construct the portfolios with specific risk/reward characteristics. They handle the reporting. They may even be able to provide investors with access to hedge funds that are ostensibly closed for investment, because they can provide these hedge fund managers with a stable base of assets. Of course, the advisors also charge a fee for their services, so investors may need to be wary of the layering effect these costs on performance.