Funds of hedge funds (FoHF) are an alternative vehicle of investing directly in single-manager hedge funds, as they comprise a pool of hedge funds that provides investors with diversification. The question that arises is if the returns yielded by the FoHF are driven by idiosyncratic factors justifying existing management fees or they are just result of market movements. According to BarclayHedge, the assets under management in the hedge fund industry reached almost $3.2 trillion in the second quarter of 2015, out of which $467.7 billion are attributed to FoHF. It is obvious that FoHF constitute a large and growing market that requires a lot of attention from the investors.
FoHF theoretically have a lot of advantages compared to the single manager hedge funds that render them into a very popular investment choice. First of all, the investment in a well-diversified basket of hedge funds implies reduction of fund-specific or non-systematic risk. Secondly, FoHF managers should be expected to have the skills in order to invest in the best single-manager hedge funds and ensure a better market timing among the various hedge fund strategies. Those advantages could mean that FoHF managers are able to channel alpha above the one of the underlying hedge funds.