Fees on Fees in Funds of Funds

Journal of Investment Management, Vol. 2, No. 4, Fourth Quarter 2004

Posted: 10 Dec 2004

See all articles by Stephen J. Brown

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)

Bing Liang

University of Massachusetts Amherst - Department of Finance

Multiple version iconThere are 6 versions of this paper

Abstract

Funds of funds are an increasing 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. One would expect that the information advantage of funds of funds would more than compensate investors for these fees. Unfortunately, individual hedge funds dominate fund of funds on an after-fee return to Sharpe ratio basis. In this paper we argue that the disappointing after-fee performance of some fund of funds might be explained by the nature of this fee argument, and that fund of funds providers may actually benefit from considering other possible fee arrangements. These alternative arrangements will improve reported performance and may make funds of funds more attractive to a growing institutional clientele.

Keywords: Hedge funds, funds-of-funds, incentive fees

JEL Classification: G00

Suggested Citation

Brown, Stephen J. and Goetzmann, William N. and Liang, Bing, Fees on Fees in Funds of Funds. Journal of Investment Management, Vol. 2, No. 4, Fourth Quarter 2004. Available at SSRN: https://ssrn.com/abstract=629444

Stephen J. Brown (Contact Author)

New York University - Stern School of Business ( email )

Stern School of Business
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William N. Goetzmann

Yale School of Management - International Center for Finance ( email )

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National Bureau of Economic Research (NBER)

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Bing Liang

University of Massachusetts Amherst - Department of Finance ( email )

Amherst, MA 01003
United States

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