Fund of hedge funds add value through strategic allocation rather than active management, according to a new study by EDHEC.
Despite institutional investors' growing interest in FoHFs, to date, little attention has been paid to their added value and/or the sources of their added value, despite a distinct lack of transparency and a double-fee structure, which makes them relatively costly investment vehicles.
The new study by Noël Amenc and Mathieu Vaissié of the EDHEC Risk and Asset Management Research Centre, entitled 'Determinants of Funds of Hedge Funds' Performance', has found that 89 per cent of the 100 top funds of hedge funds in the sample turn out to add value at the strategic allocation level, but only 31 per cent at the active management level (20 per cent created value through both strategic allocation and active management).
The full results of the study are to due to be presented at the EDHEC hedge fund days at The Brewery in London on 15 and 16 February 2006 , but other key findings include:
While FoHFs create value on average, they tend to add value through strategic style allocation, but destroy value through active management
FoHF not only destroy value through active management but also significantly increase volatility (the volatility of FoHF is on average 24 per cent higher than the volatility of benchmarks)
If they focused on strategic allocation, and as a result, stopped charging investors high incentive fees, FoHF would create much more value than they currently do
While it is well known that fund picking is a difficult task, it appears that fund of fund picking is just as difficult.
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