The Value of Funds of Hedge Funds: Evidence from Their Holdings
32 Pages Posted: 7 Dec 2012 Last revised: 13 Jul 2014
Date Written: July 7, 2014
Abstract
We examine the portfolio holdings of Funds of Hedge Funds (FoFs) to identify the channels through which FoFs add value for their clients. FoFs offer access to a diversified portfolio of funds that would be costly for constrained investors to manage on their own. Though we find only limited evidence that FoFs exhibit skill when selecting hedge funds, we find strong evidence that FoFs make skillful termination decisions. After FoFs divest from a hedge fund, those hedge funds subsequently underperform and fail more often. Our evidence indicates that FoFs learn and skillfully process information about their portfolio funds after they become investors, enabling them to forecast poor future performance. Our study suggests FoFs serve an important role as intermediaries in a market characterized by significant frictions and transactions costs.
Keywords: Hedge Funds, Funds of Funds, Portfolio Management
JEL Classification: G11, G23
Suggested Citation: Suggested Citation
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