Fees on Fees in Funds of Funds
Stephen J. Brown
New York University - Stern School of Business
William N. Goetzmann
Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)
University of Massachusetts at Amherst - Department of Finance & Operations Management; China Academy of Financial Research (CAFR)
NYU Working Paper No. FIN-02-031
Funds of funds are an increasingly popular avenue for hedge fund investment. Despite theincreasing 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 attractivehedge 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 inhedge 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 feecomponent 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 feearrangement that may provide better incentives at a lower cost to investors in these funds.
Number of Pages in PDF File: 31working papers series
Date posted: November 3, 2008
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