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Chapter 11: Overview of Hedge Funds > Fund of Funds - Pg. 217

Chapter 11 Overview of Hedge Funds 217 Fund of Funds A fund of funds is an investment fund that invests in a portfolio of other investment funds, rather than investing directly. A fund of hedge funds attempts to provide a broad exposure to the hedge fund industry and risk diversification. They typically charge a management fee of 1% to 1.5% of AUM and also receive performance fees that range from 10% to 20%. As a result, if a fund of funds invests in a dozen hedge funds that charge "2 and 20" fees on average, total management and performance fees paid by fund of fund investors could be about 3.25% and 35%, respec- tively. For some investors, these fees outweigh the benefits of investing in hedge funds. However, many investors who may not qualify to invest in hedge funds because they have insufficient capital to invest, or are not recognized as qualified investors in the United States by the SEC, will invest in a fund of funds as the only vehicle through which they can invest in hedge funds. In addition, since many fund of funds have investments in 10 or more different hedge funds, they provide more diversification than some investors might achieve directly due to limited amounts of investable capital. See Exhibit 11.17. Some high-net-worth and institutional investors will channel money through a fund of funds because they value the due diligence process by which fund of funds weed out poor hedge fund managers. However, there are many recent examples of inadequate due diligence, where fund of funds have performed at or worse than hedge fund indexes, based on poor investment decisions that reflect inadequate investigation of hedge fund practices and investment strategies. For exam- ple, many investors were distraught when they were told that their fund of funds at Goldman Sachs and Man Group had invested in Amaranth Advisors, a hedge fund that declared bank-