Single-Strategy Funds of Hedge Funds: An Effective Diversification Tool
Single-strategy funds of hedge funds have not been the fund structure of choice among investors. So far this year, BHA has received 94 funds of hedge fund mandates. Of those, 70 have been for multi-strategy funds of hedge funds. Although the multi-strategy structure continues to be preferred among investors, single-strategy funds of funds are extremely useful and essential for investors to gain the proper diversification within certain niche areas of the alternatives industry.
A good example of a niche area is commodities. As I wrote in “CTA/Managed Futures Interest on the Rise, But Will It Continue?” (Investor Monitor, October 30, 2009), CTA/managed futures funds became a popular strategy among hedge fund investors because of the funds’ strong performance during the economic recession. This was made clear by the HFN CTA/Managed Futures Index’s outperformance of the broad industry index by 25 percent during 2008.1 Many investors have used multi-strategy funds of hedge funds to achieve proper portfolio diversification. However, single-strategy funds of hedge funds can also provide diversification when it comes to complex strategies such as CTA/managed futures.
An advisor at a family office based in Geneva, Switzerland, explained to a BHA analyst that she has been intrigued by CTA/managed futures funds after seeing how well they navigated the economic recession when compared with other funds. The advisor also voiced a strong interest in CTA/managed futures funds of funds because they would allow her clients to have proper diversification with funds that have varying holding periods and exposure to hard and soft commodities as well as trend and non-trend following approaches. She also wants to gain exposure to both discretionary and systematic managers in the space. This advisor has decided to research CTA/managed futures funds of hedge funds in addition to seeking top performing single-manager funds.
With the varying structures seen among CTA/managed futures funds, it is a formidable task to properly diversify a portfolio using single manager CTA/managed futures funds. It is a job that involves much due diligence and tracking of numerous funds with varying tendencies. By allocating capital to CTA/managed futures funds of funds, an investor can get the proper diversification through the underlying funds. Also, asset managers such as family offices will benefit from the additional research: in addition to conducting their own in-house due diligence, the funds of funds will also be performing due diligence and portfolio management.
Investors looking for true diversification within a particular segment of the hedge fund space can do so at the funds of funds level. Although multi-strategy funds of funds are the most popular and well-known type of funds of funds, single-strategy funds of funds cannot be overlooked when seeking optimal performance and diversification within a particular niche of the industry.
1 HedgeFund.net, “Strategy Focus Report: CTA/Managed Futures,” October 2, 2009.