Fund of Funds Resources

Does anyone have suggestions about books, websites, etc. on the decision making process fund of funds go through? There are a couple of books on Amazon that either got mixed reviews or are old.

Specific topics I am trying to understand:

  • The allocation decision process

  • Portfolio construction

  • Decisions relating to emerging managers

  • Average fees / terms / performance

I have met with a good number of FoFs and have my own views but I’m trying to get an insider’s perspective.

Thanks in advance for helpful responses.

Are you thinking hedge funds in particular or any asset class?

Hedge funds only

I’m afraid I can’t be of much help then. Know more about the PE side of things. My firm does use a bespoke HF fof product but I can’t say anything from the point of view of a hedge fund looking to get included in a fof other than the big shops often have very large numbers of HFs on their books (200+) which they can include in different mandates for clients. I think there are some specific incubator funds too looking to seed start-ups but I really have no knowledge on how to access them. Hopefully someone else here can help you out more.

Hey Bro

I like learning, so I started doing some research on this topic because I realized I knew very little about this. These are some things I read, figured I’d share in case they’d help:,%20Morningstar%20Investment%20Management%20.pdf

These mainly address your first 3 bullets (I think). And I came across this while reading:

Thanks rawraw, I appreciate the help.,%20Morningstar%20Investment%20Management%20.pdf

Slide 21 here is pretty interesting IMO. There is a big spread between top decile and bottom decile funds, which is what you would expect in a low growth back drop but essentially zero sum game (aka, the stock market). I didn’t expect it to be quite that big of a spread but I’m not that surprised.

That said, I’m not sure if any of these links really hit the mark for me. I have a couple of fund of funds and family offices trying to get me to take [vast 8 figure sum of wealth]. This is obviously a high class problem and appealing to me. My concern is I don’t understand what the people on the other side of the table are thinking, so I don’t want to sell too cheaply. These guys have a lot of experience meeting managers, evaluating them, and making allocations (or not). I know a lot about my investment “product” but know almost nothing about this aspect of the business, so this could potentially be one sided if I am not careful.

So basically the original questions still stand, maybe slightly more clarified here:

  • Why do FOF make their specifica allocation decisions?

  • What are the specific considerations with emerging manager allocations?

  • What are the average fees / terms for L/S equity strategy allocations?

If anyone can get me on track I would appreciate it. I haven’t found a lot online, most of the FOF materials I’ve seen are about beta vs. alpha generation.

I use to work in investment consulting, so I have a broad overview of the hedge fund of fund allocation prespective.

A great resource is a little secret - public pension funds, who are some of the biggest investor with hedge fund of funds, often put their investment meeting presentations and due diligence materials online. Within those online materials, you should find hfofs allocation overviews, manager selection process, etc.

You can find a wealth of information with a little creative googling. For example:

generally, you search for - filetype:pdf

To be completely honest, I haven’t really heard of a great hedge fund allocation process. Folks largely throw around the word “diversification” a lot. They want to see managers who have strong relative and absolute performance against other hedge fund strategies and public market benchmarks. But one thing that is an unspoken desire - positive absolute performance when the public equity markets goes down.

Alot of firms say they use strategy specific analysis for the capital allocation process, factor analysis, as well as examing the capital markets for opportunity sets i.e. back in 08/09 it would of been logical to allocate more to distressed funds rather than stat arb, or if the hfof manager thinks equity is frothy now they’ll probably allocate more to L/S equity and merger arb than global macro. Generally, I think people are more qualitative than quantitative.

As a hedge fund manager you must answer the following questions:

  1. What is the market opportunity you are trying to exploit?
  2. How do you measure the potential for alpha and the size of opportunity set?
  3. What is the risk/reward of the opportunity set? What is the absolute downside risk of the opportunity set?
  4. How do you systematically exploit the opportunity set? Is it repeatable?
  5. How do you do this more competitively than anyone else?

Of course you have to show people you can answer these questions with your past performance. Of course, the bigger the opportunity set, the better the risk reward, the diversification compared to other hf strategies and public benchmarks, the more $ you get.

Excellent, thanks BiPolarBoyBoston. Calpers is too big for me as the strategy caps out at a few hundred million and I’ve heard Calpers doesn’t want to mess around unless they can write very big checks. Nevertheless, thanks for the links, that looks like good perspective.

Edit up front: This is more about how it would go down for you getting your strategy in a FoF, not how the FoF actually operates. You’re asking about the latter, but I’ll share my experience doing something similar on the mutual fund side.

This (essentially platform/product placement) is similar to what I do but I only work in the 40-Act world. Still, there are some similarities. One big one that you seem concerned about is that you’ll have little to no input on is the final allocation of the FoF. Where and how your strategy fits in to their FoF isn’t your call. They’ll learn everything there is to know about your product and allocate accordingly. The only time I’ve ever had a buyer take any sort of input is when the strategy is capacity constrained. Otherwise, it’s not up to you.

As for the fees/terms/performance question, in general a FoF manager can fire you at any time and with very little notice. It may be different with hedge funds given they may be holding less liquid assets and might need time to raise cash. Fees are a little trickier. Do you have eVestment? That would provide you with fee information on similar products. Even still, the FoF manager is going to have a number in mind. Sometimes you can get them to budge a bit here or there, but unless you run a very unique strategy with stellar returns, they hold all the cards so you’ll get the fee they offer you. If you’re raising plenty of money at 2/20 then there would never be a reason to go into a FoFs product.

One more thing, it sounds like they’re courting you and really want you in their product. That’s good, really good if they’re being genuine. But, just a warning, hedge FoFs is still a growing market. There are companies out there looking for any HF to participate. Try to figure out how sincere they are then you’ll know how much leverage you have.

tl;dr - As an asset manager looking to get your product on a platform/FoF, you essentially have no leverage. You won’t get much if any say in portfolio construction/allocation and you’ll get the fee they offer you.

Thanks, Sweep. Not tl;dr, I appreciate it.

I do not have eVestment. The strategy calls for a 3 year lockup and they already know that we’re not even going to discuss that and they’re still on board. In fact they originally mentioned it, prior to that I wasn’t interested in the discussion at all.

I think they are genuine to the extent that everyone in this business is a lying a-hole (but other than that, they seem like legit guys). They have been pursuing me, not the other way around. I know they are coming to me because of the pedigree and unique strategy, not just “any hedge fund.” We know all the same people in this particular niche and I have an extensive reference list, which they have contacted.

I think I have some leverage based on the above. Whether it’s a lot or a little I don’t know. It’s probably a lot though based on how much time they have spent on diligence.

That sounds good for you then. So it probably just comes down to capacity. How much room do you have left and can you fill it organically while charging a much higher fee? If so, tell these guys to kick stones.

It’s a concept that can support a few hundred million. They are talking about setting me up from zero so the capacity today is a few hundred million. So that’s a different game. The question was asked broadly because there are other FOF that have expressed interest in coming in with $5-25mm checks within the first 6-12 months post-launch, so I think this is going to be an ongoing discussion for some time. As we all know, talk is cheap until there is ink on the page.

My preferred fee structure after fixed costs are covered is 0/25. I am quite confident I can make money. I don’t need a management fee though I would clearly take one. The lowest I would go is 1/15.

Probably to my detriment, I am not in a huge hurry to scale AUM. With a good two year track record after launch, it would be easy to ramp to $150+. To me it seems like marketing is largely a waste of time unless you can basically show up, pitch the numbers and process, and get a check fairly quickly. If you have to spend a lot of time convincing someone, the product isn’t good enough and should be the focus. But maybe that’s just me.

Does demand for funds decline when the indexes are roaring?

LPs want to invest when the market is already way up. Good luck finding investors in early 2009. Business risk and investment risk for hedge funds are inversely correlated.

Do they want to invest when the market is up because of the allure of outperforming a crash, or just because the market is expected to go up further? And appreciate the insights

People want to invest when the market is up because they perceive it as less risky than when the market is down even though that’s objectively wrong. But that’s human nature and will not change.

When the market is way down, you are unlikely to get much or any capital unless you have a long track record and deep connections. You may also have your capital pulled even if you are doing well. That is the point of maximum business risk. On the other hand, it’s the point of minimum investment risk because the market is already way down.

You can flip that at the top of the cycle – people want to invest because they market is up. The strongest motivating factor on Wall Street is FOMO (Fear Of Missing Out). This is the point of minimum business risk because you will have few redemptions unless the performance is terrible and it is easy to raise capital (relatively speaking). Unfortunately though, it’s the point of maximum investment risk because you are paying top of the cycle prices.

Nobody said this stuff is easy.

^What’s your strategy’s correlation to the S&P 500?

It’s about 30-40% net exposure to the R2K so it should have pretty low exposure to the S&P. I haven’t run the exact correlation numbers. It is not a closet indexing fund that dreams of beating the S&P by 100 bips.

I worked as an asset consultant, then fund of hedge fund and now working for an asset owner. I think I may be in the position to address some questions. Your questions are valid but unfortunately, the process is never clean-cut.

Why do FOF make their specifica allocation decisions?

Generally, it depends on cashflow, bottom line and then what’s already in the portfolio. If my sales is telling me that he expect to receive $100m hot money, then that determines my liquidity requirement. If he tells me that we purchased another firm and there will be a $100m “permanent” capital then I can put money to illiquid strategies. Bottom line and what’s already in the portfolio are self-explanatory. Let me know if you need more clarification.

What are the specific considerations with emerging manager allocations?

Track record, pedigree, portfolio fit an terms. I gernerally would also consider if there’s skin in the game, company ownership (e.g. if the fund is partially owned by AMG or the like). Business strategy is something I like to understand. At the end of the day, we invest in people and in a business. If the founder has no plan of expanding, diversifying clients or want out in 3 years to cash in then there is really no point to invest.

What are the average fees / terms for L/S equity strategy allocations?

Depends on size. 0/25 is commendable. 1/15 is very palatable. I generally write $30-$50 but then I don’t go for small fund so my bargaining power is less. I also dont’ do much L/S equity, prefer credit-based.

Correlation of 0.3-0.4 is too high for me. I guess it all depends on the net outcome. There’s a prominennt fund running a long bias strategy with 15% “alpha” with correlation of 0.5 is, I’m ok with that.

My apology for the rather flippant tone and grammar, I’ll come back to edit my response in due course…maybe.