Funds of Hedge Funds

A fund of hedge finds (FoHF) is an alternative investment vehicle that invests in other alternatives, generally hedge funds. The basis rationale for this is asset allocation. A manager of a FoHF decides on the sector or types of funds that are most appealing, assigns weightings to those sectors, and looks for the best fund managers within each sector.

Critics of the fund of funds concept point out that they generate fees on top of fees and expenses on top of expenses. If you want asset allocation, you can get it without the extra layer of fees and without the extra layer of mystery about what the underlying today stock market investments are. Besides, why stop there? Why not create “funds of funds”, “funds of funds of funds of funds”. And so on ad infinitum?

Proponents respond that no single fund company can afford to hire the very best managers in all markets, whereas a fund of funds has the freedom to compile a portfolio of the best manager in the world. There are, however, at least two assumptions hiding in that argument- namely, that the fund of funds manager can identify the best managers and that the FoHF’s asset allocation will add value, not subtract it.

Other Alternatives

One of the biggest problems associated with hedge fund investing has been the lack of transparency into fund’s positions, strategies, and risks. An extreme example that came to light in late 2008 is perhaps the greatest financial fraud of all time, perpetrated by Bernie Madoff, and apparently facilitated by numerous intermediaries – wittingly an /or unwittingly. While Madoff never operated a hedge fund, billions of dollars were raised by hedge fund and fund of fund managers who offered feeder funds, funds that apparently served no purpose other than to collect fees and send the money to Bernie. The secrecy that still exists in the edge fund industry can have no grater illustration than the realization that many hedge fund managers had never even heard of Madoff or knew that a feeder fund was until he surrendered to authorities in December 2008.

The problem of lack of transparency has been tackled in two ways: by hedge fund managers offering full position-level transparency in separately managed accounts that are owned by the investors; and by financial engineers who have developed hedge fund replication strategies that are intended to offer hedge-fund-like returns and use sophisticated mathematical and computer techniques to reverse engineer hedge fund strategies, and to attempt to replicate the returns using liquid instruments, especially futures contracts. Both of these approaches are in an early stage of development, but they are garnering significant attention from investors who wish to retain the diversification benefits of alternatives without paying the price of lack of transparency, liquidity, and control.

Stocks or Mutual Funds?

While some may find that idea of comparing stocks to mutual funds a little bit odd, since mutual funds are often made up of stocks, bonds, or some combination of the two, it is quite necessary to compare the two when it comes to deciding what is best for your financial outlook. Some of the more notable differences will be discussed below in order to help you decide which investment type is more suitable for your financial situation.

When it comes to investing for the everyday man or woman you really can’t beat mutual funds. Stocks carry hefty fees for buying, selling, and transferring that significantly hinder any profits that would otherwise be made from the transaction. In fact, these fees often serve to deter the trading of stocks rather than encouraging it. Perversely, big trading companies offer hefty discounts for their big spenders making the stock market trading game seem even more exclusive by making it easier for those who already have a great deal invested than they make it for the new guy trying to make his way on the market. Mutual funds are much more accessible to those who don’t have massive fortunes available to invest and need to make small steps (such as $100 a month) towards their financial and investment goals.

Mutual funds typically carry less risk than the average stock purchase as well. This happens for many reasons. First of all mutual funds are not generally invested in one sector, industry, or company. For this reason if one of the stocks fails, the proceeds from the other stocks and bonds purchased will help mitigate the loss, making it less noticeable. At the same time, the loss is shared by a large group of people so that even if a slight overall loss is experienced as the result it will be much less noticeable than if the stock purchased was yours and your alone. Finally, the fact that the funds are already diversified to a large degree helps insulate from huge fluctuations in the market such as those seen recently when the sub prime mortgage industry bubble popped leaving many investors ducking for cover.

Share the wealth. Share the risk. Mutual funds offer a sense of community, commonality, and shared risk among those who buy into a specific mutual fund. This is a good thing most of the time as it enables a large group of people to share a much smaller portion of risk than if they were buying stocks of their own volition. The existence of a fund manager means that there is someone “in the know” who is looking after the profit of the fund and that has the success of the fund at heart. This is something that you won’t find when investing stocks. In fact, when it comes to the stock market the only people that really care about how your stocks are performing are those that you pay to care for these things such as your financial advisor, accountant, and/or stockbroker.

Another thing to consider about mutual funds is that they are much easier to use and/or trade than stocks. They are much less expensive to trade as well. You can purchase mutual funds from your local bank, online, and through many online trading companies as well as through many company 401 (k) plans. In other words mutual funds go out of their way to make themselves accessible. The most important thing, really, when it comes to buying mutual funds is that you devote some time to studying the history and performance of the fund you are considering to purchase as well as the fund manager for peace of mind.

As you can see there are a lot of differences between stocks and mutual funds. For small investors mutual funds are often the best route to take. They pose less risk, impose fewer fees, and place owners in a position to accrue steady, if slow, returns on their investments.

Bonds and Mutual Funds Explained

When it comes to investments, perhaps the best-known type is stocks. We hear about how popular stocks are doing every day on the news, and when the economy takes a turn for the worse, we hear about how the stock market in general has plummeted. But stocks are far from the only type of investment out there.

There are some types of investment that are completely unrelated to stocks. Many others are based on stocks, either in part or in full. Here are the basics on two popular types of investments: bonds and mutual funds.

Bonds

Bonds are often mentioned in conjunction with stocks, but they are two entirely different things. Stock shares are ownership interests in companies that choose to sell them. Bonds, on the other hand, are debt securities.

Stocks and bonds do have something in common in that they are both used by corporations to obtain capital. But bonds may also be issued by local, state and federal governments. And while the money received from the sale of stock is not repaid, money received from the issue of bonds is. A bond is similar to a loan, because the principal plus interest is paid back after a specified period of time.

A unique aspect of government bonds is that the interest received may be tax exempt. Federal government bonds are not subject to federal income tax. State and municipal bonds usually aren't taxable if you live in the state where they are issued.

Mutual Funds

Most investors agree that in order to invest successfully, you must diversify. This means investing in a variety of investment types. One of the easiest ways to do this is to buy into a mutual fund.

Mutual funds are pools of money that are invested in several different assets. They may include investments in stocks, bonds or cash, or a combination of the three. These funds are managed by professionals who know how to get the best possible returns.

Some mutual funds allow investors to buy shares with one lump sum investment. But most allow investors to put money in on a regular basis. Mutual funds may be purchased through banks, brokerage firms, or directly from financial companies. Those purchased through a bank or brokerage often require the payment of fees or commissions, while most mutual funds purchased directly from financial companies do not.

When purchasing a bond or a mutual fund, it's important to take a look at its past performance. Bonds are rated according to the issuer's credit history and current status. Mutual funds must publish a prospectus each year that details their performance. These tools make it easier for investors to make an informed choice.

Like all investments, bonds and mutual funds carry some risk. A financial advisor can help you choose the right ones for your purposes.