Hedge Funds-Of-Funds Lag Benchmarks

Despite their warm reception, it seems that hedge funds-of-funds may not be as smart an investment as they at first seemed, according to The Wall Street Journal.

Funds-of-funds attracted investors in droves between 2003 and 2004 because they offer the chance to invest simultaneously in several top-performing hedge funds, much like a broad stock-index mutual fund. However, it turns out, critics say that the hedge funds-of-funds trail, not track, the funds they invest in. Indexes managed by Chicago-based Hedge Fund Research, for example, are down 8% this year, or settling at about $2.4 billion.

And investors have been disappointed, resulting in significant outflows from the $12 billion industry.

Of the 25 hedge fund index providers, eight offer products that provide for investment in their hedge-fund indexes. Some indexes fail because they only list hedge funds with track records of two years or longer, and therefore don't reflect fledgling start-ups that fail, or those that immediately take flight.

Some of he biggest, most robust funds refuse to provide data to these indexers or include their funds in fund-of-fund products, including big names like the Man Group of London, Highbridge Capital Management in New York and London-based CQS Ltd.  Other funds provide data, but accept no new investors.

"Because of the requirements investable index funds have, in terms of needing funds to be open to new cash, they tend to get second-tier funds as the best funds are closed to new cash, " said Francois-Serge Lhabitant, head of research at Kedge Capital, an alternative investment group in London.

Besides investing in sub-par performing funds, these index products also charge annual fees of between 1% and 2%, plus underlying fees to the funds, further eroding gains.

For example, the Credit Suisse/Tremont Hedge Fund index is up 6.6% since January, although the investable fund that tracks has enjoyed gains of less than 5%.  Likewise, the MCSI hedge fund index is up 5.1%, but the correlating investable asset has gained only 2.9%.

Still, supporters say the products address a need in the market.

"The hedge-fund industry needs a benchmark to compare itself off, and it is more realistic to compare itself to an index that can be invested in," said Alan Dubois, chairman of Lyxor, the hedge fund arm of Societe Generale of France. 

The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.