Here’s a question for you: What is the actual purpose of FoF ?

In theory, they are supposed to do the due diligence, the forensic accounting, the deep background checks that ordinary investors cannot.

Then once they identify a group of funds they want to allocate capital too, they are supposed to run the asset allocation (cash bonds stocks).

Beyond that, they should be diversifying across styles, strategies, cao sizes, geographic regions.

Additionally, they are also in charge of maintaining oversight of the funds — watch performance, style drift, etc.

~~~

Now ask yourself this: How many FoF actually do all that? How many FoF did that (competantly) for Madoffs.

Category: Bailouts, Hedge Funds, Investing, Legal

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

26 Responses to “Why Do Fund of Funds Exist”

  1. harold hecuba says:

    they exist to collect management fees in order for ivy league mba types to continue pretending that they are BEST IN BREED until they suffer from MAD COW DISEASE

  2. daniellepark says:

    B, congrats on finishing your book.
    Madoff and his like are the extreme fraudsters, but the truth is that the money biz is full of sales dudes that pass their sales ability as money management expertise. They can’t oversee other managers, ’cause in truth they have no blinking clue what or how to check anything. And then there are the unit holders with no clue and so the blind lead the blind from the sublime to the ridiculous every cycle.
    See Management risk in the money business: http://www.jugglingdynamite.com/blog/_archives/2008/12/16/4023948.html

  3. leftback says:

    To provide a source of funds for young Czech girls to do lines of coke with people too lazy to run a hedge fund?

  4. They are the hucksters and thieves Wall Street has always had. Now I have to go back and try and find the list of them I made when you were at your old place.

  5. Stuart says:

    better to buy an ETF and save yourself all those fees. They exist because the managers don’t know what they’re doing so they hedge the crap out of their positions by over-diversifying.

  6. jason says:

    To make the most money for the FoF with the least amount of work. It is glorified consulting. It sounds cool but not as cool as the FoFoF that I just started. $1M minimum required for investment. All questions answer at $100,000 per word. My contact info is at http://www.fofof.com.

  7. leftback says:

    Fund of Funds (n): An extinct entity, once common in the early part of the 21st century. They were run by a group of people who didn’t have the confidence to decide how to manage money, yet were managing money for other people who didn’t have the confidence to manage their own money.

    They existed only in bull markets, and became extinct during President Obama’s first term in office, shortly after the appointment of Rep. Elijah Cummings (D-Md) to the post of Chair, House Financial Services Committee.

  8. John Carney says:

    Cluster stock answers here:

    Why Do Funds Of Funds Exist?
    http://clusterstock.alleyinsider.com/2008/12/why-do-funds-of-funds-exist

  9. leftback says:

    To relieve the infinite boredom of FOMC day?

  10. Grandpa Bowman says:

    cao sizes?

  11. Garuda says:

    The idea was that a fund of fund manager could do the kind of due diligence that a mere sophisticated investor could not do. Then, the fof manager would charge a fee for the work.

    That was the idea.

    For some reason, I still don’t think we’ve heard everything about how the Madoff family somehow escaped regulatory scrutiny for all of those years.

    Too many folks had figured out that it was a scam — the SEC seems to have had a very steady gaze elsewhere.

  12. pmacaodh says:

    Sure, the list of duped providers is almost a who’s-who of big FoF names, but there still exist FoF providers that provide a value-added service in return for a fee – they have avoided the blow-ups and frauds and have relative outperformance this year.

  13. Mannwich says:

    Fire up the printing press!

  14. leftback says:

    They are vowing to use all tools again…
    Sell the news?

  15. Mannwich says:

    @lb: Not yet. Going to mindlessly run for a while, THEN sell.

  16. Brown Ram says:

    In addition to the reasons that you cited, I always thought that part of the reason why people invested in Funds of Funds was because it was a back-door way of getting access to closed funds or funds with high minimum investments.

  17. pamtonia says:

    This is a phenomenon of HF bubble, like the everywhere empty houses…Get revenue with little cost. Let’s see which one disappear faster: underlying funds or FoFs?

  18. BKM says:

    Proper allocation of assets among assets classes as well as research and due diligence is the reason they exist. However fee scraping, which is more common, is why many will and should go out of business.

    READ THIS QUOTE from an article in my local journal regarding the Madoff scheme.

    ” KSM parses clients’ investments among a number of investment firms and investment vehicles. One of those firms is Redmond, Wash.-based Future Select Portfolio Management Inc. Future Select in turn invested through Tremont Capital Management, which in turn placed the money with Bernard L. Madoff Investment Securities LLC. ”

    Multi Level Marketing at its finest. UNBELIEVABLE!!!!!!!!!!!!!!!!!!!!!!!!!

  19. Just to try and address the question at the end of Barry’s post:

    In most of the articles I’ve read on this Madoff fraud/ponzi scheme case, there was some mention of fund of funds or hedge fund advisers who had either invested in the fund or bypassed an investment.

    Here are a couple of recent article excerpts to compare and contrast.

    From Bloomberg:

    “Hedge fund investment adviser Aksia LLC warned clients last year not to put their money with Madoff after learning of “red flags” at his company, including that its books were audited by a three-person accounting firm. ”

    Here’s one example of an adviser/FoF making the right call. I recall other examples of FoFs bypassing from the articles I’ve read, but can’t recall their names offhand (some firm execs maintained anonymity, like the one cited in Andy Serwer’s Fortune article). Some even go so far as to check out prospective funds and their managers by hiring private investigators to watch them!

    Of course, there are the articles pointing to the major flubs made by other fund of funds, like this one from FT.com.

    So, take these points for whatever they’re worth. I guess there were some advisers who did their job well, and some big ones who were not so skilled or lucky. I’m not an advocate or opponent of the fund of funds industry, just a casual observer of this debate.

  20. AGG says:

    harold hecuba and others with similar comments are right.
    and now the news media coincidentaly starts pushing the idea that people are too stupid to manage their own money. Isn’t it amazing that just when so many money managers turn out to be con men who specialise in inventing new terms for “fee” (premium, toll, charge on, extra load, low load, add on, etc.), we get stories about how people need money managers to save their 401ks. Bullshit. If you have the time, invest your own dime. I wish that all on line brokerage fees were cut by law to 1 dollar per trade. That way people would choose the firm by the rapidity of execution rates. Remember, the slower the execution, the more front running.

  21. AGG says:

    If you have the time, invest your own dime.

  22. Garuda says:

    Larger question: what about other geniuses who always had a steady, consistent rate of return, no matter what?

    Jack Welch? John Chambers?

    When does the investigative research begin?

  23. ardano says:

    Okay, I’ll take the other side of the trade…

    Back when we had financial markets, some FOF’s did perform a function. Like their long-only cousins , some consultants do indeed understand the benefits of an allocation model. Many investors can invest in a single hedge fund, but do not have the assets for multiple funds. A FOF is helpful to expose a potential investor to multiple strategies.

    There are similar examples of ideas in the long-only world. For instance, who can afford to buy into Warren Buffet directly through Berkshire? There are vehicles used to mirror Buffet’s portfolio for a much smaller share price.

    I am not defending abusive FOF’s. In the long-only world, consultants are usually able to get their cleints fee reductions. Through so-called wrap fee platforms many consultants and retail brokers are able to put together long-only with some alpa for investors who are one step above retail but one step below a true institutional client.

    Over time the FOF’s began to resemble the funds they provided access to. In any crowded trade there are always abuses at the top. Hedge funds as an asset class are now being unwound. To paraphrase Jimmy Rogers a few years ago, we’ve now discovered that there aren’t that many smart guys with laptops…and investors did buy too many Ferrari’s.

    However, there are many smart fund managers, who are honorable and do have their own money at risk along with their investors. There are also decent FOF’s who conduct valid research and monitor performance. Are the fees too high? Of course, but they’re too high in all classes of alternative investments. Pre-Madoff, hedge and fof’s were beginning to alter their models. That will obviously continue now. Unfortunately, it will also mean more unwinding in the first quarter of 2009 as funds will again have to sell positions to meet redemptions.

  24. 2008 has been a catastrophic year for money managers and financial advisers. Most look incompetent and even irresponsible. Yale just reported a 25% drop in the value of its portfolio. Harvard’s also lost big along with banks, mutual funds, insurers and charities that were in FNM and Freddie, AIG, etc.

    Pension funds are hurting due to mismanagement, and municipalities are seeking bailouts after getting caught playing the auctions rates markets.

    But what’s worse is that boards of directors, sophisticated investors and government agencies as well as millions of individuals thought their “professional” money managers could preserve their capital and even beat the markets.

    A lot of fired money managers will be getting coal in their Christmas stockings this year, and many more should.

  25. Temjin says:

    Just as the link John Carney posted, FoFs exist only to provide individual access to alternative investments that may require a minimum of hundred of thousand of dollars to even open an account.

    I agree with ardano on certain things and I do feel that FOFs do have a place here. Where else could one invest in a real professional fund manager (or rather, TRADER) who is capable of producing a return over risk investment that are much much better than any other long only funds out there? There are lots of legendary traders out there who have made their clients extremely rich, but historically, it has only been accessible to the connected fews.

    FOFs have made it possible for the average mums and dads to further diversify their investment portfolio through these alternative investment classes. The Madoff case is definitely an unfortunate and unexpected event. Who would have though a person of such high regards to do something like that anyway? But that does not ultimately means all the other FOFs out there are exist to grab fees and do not provide any value. Ok, in a real sense, they do not provide any real economic value, but at least they provide funds to hedge funds who in turn provide liquidity to the market as a whole.

    So I agree there are lots of decent FOFs out there who do their due diligence well. But “black swan” events do happen and this is why managers / strategies diversification is a core part of the FOF structure.

    I personally see the redemptions as an opportunity to future hedge fund managers to take back the market share once confidence is back up again. As well as taking advantage of extreme oversold assets due to the forced liquidation by hedge funds through redemptions.

  26. KatoKryle says:

    WE PROPOSE A NEW LAW that requires all EXECUTIVE compensation packages to pay out based on % of YEARLY WEIGHTED AVERAGE EBITA for ALL EXECUTIVE LEVEL POSITIONS in all publicly traded entities.

    Thereby policing Exec behavior to produce sustainable, strategies and cash flows from operations as opposed to quick hits that result from unwise risk taking and or accounting artifice. Who cares what the exact % is that would be doled out to the EXEC as long as the payout methodology is based on a potential flash-in-the-pan NI that directly promises unlimited short-term upside compensation and complete ruin thereafter for all save for the EXEC.