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S&P backing for funds of hedge funds

Standard & Poor’s Fund Services says it is worth investors paying the extra cost for funds of hedge funds relative to multi-strategy hedge funds because they provide diversification of manager as well as investment style and strategy.

The company’s latest update on the fund of hedge funds sector coincides with the FSA’s announcement that it is considering allowing retail investors access to funds of hedge funds.

The Standard & Poor’s report looks at some of the risks of investing directly in hedge funds in the light of the collapse of multi-strategy hedge fund Amaranth in September.

Although multi-strategy funds invest using a range of styles and strategies, such as equity long/short, merger and bond arbitrage, Standard & Poor’s says these are limited to the styles and strategies that the hedge fund manager is best at.

S&P Fund Services analyst Randal Goldsmith points out that multi-strategy hedge funds provide diversification by investing in different stocks and strategies, but adds that there are specific risks with hedge funds against which fund of hedge funds can mitigate.

“One issue is that performance fees on hedge funds are asymmetric in that the manager will share in the positive results, but if things go wrong, the manager does not have a share in the losses.” says Randal.

“Managers benefit from a series of volatile returns, although I am not suggesting that is what they set out to achieve.

“Funds of hedge funds limit this by ensuring the hedge fund managers they invest with also invest in the funds they manage,” he adds. “There is a strong case for investing in funds of hedge funds, even if the cost may be more expensive.”


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