Feb

28

The Double Dipping Hedge Fund of Funds Manager

February 28, 2004 | Leave a Comment

Think your fund of funds manager is doing the best he or she can for your investment? Think twice, hedge funds are a fee game. Every participant in one form or manner is dipping into the investor pot to make some extra cash. And this is not something isolated to fly by night shops either, some of the well known and respected names in the hedge fund community engage in this practice.   

What is it that they do? Double Dip. They may not always be seeking the best manager for their multi-strategy funds. They may be seeking the best marketing deals in each strategy they can get within each strategy. A double dipping if you want to call it.   

What they do is offer two businesses. On one side, they offer fund of fund vehicles for hedge fund investors and on the flip side they offer contract marketing agreements on the hedge fund side. So it is possible for them to not only make money from their own investors but will also clip a marketing fee for putting their fund of funds investment with a manager in any given particular strategy.   

Are you getting the best manager for lets say a long/short equity fund or are you getting a long/short equity fund that was based on the best fee deal your fund of fund manager could obtain?   

There are fund of funds touted by the industry who engage in this practice, some managing over a billion dollars, some who have received institutional money without disclosing that information I am sure.   

Shhhhh! It’s a dirty little secret. You might want to check up on your fund of fund manager and find out more information on their broker dealer business. Because that is where they are getting compensated by hedge fund managers. Who knows what rate structure that they worked up with each manager but in some fashion it could be diluting returns. And once again, it is taking away valuable business from investment banks.   

At other times it’s a cash deal only tapping into the hedge fund manager’s pockets. But are you willing to risk your money with a fund of fund manager that will pass up a good manager in a given strategy to get a better deal with a lesser quality manager? That’s the question you need to ask yourself. The other question you need to ask yourself is how you will be able to find out whether your fund of fund manager is double dipping and it is more common than you might think.   

Shopping for Fund of Fund managers is a difficult task. These are Wall Street’s finest salespeople….the cream of the crop. If you want them to justify their fees ask them point blank….are they clipping a fee to hedge funds OR what kind of activity is occurring at their broker dealer? Do they have more than just a list of hedge funds and a smooth sales pitch? Do they have a solid due diligence program in place to protect your assets?    

What I find is that the sales pitch and the actual due diligence they really perform are entirely different. Some of these fund of funds are so soaked with capital that they are just spreading the wealth out there to managers without even conducting proper due diligence or analysis. I recall one instance where a fund of fund manager needed to put $5,000,000 to work 3 days before a month end and asked ME if I knew of any funds in a a strategy he was looking for. I wonder how these people are able to attract capital when they allocate capital in this manner. Last time I checked he is running close to $750 million. Go figure.   

Top tier or not, be careful out there when you are picking fund of funds. The extra layer of fees need to be justified. Be careful who you receive recommendations from, you never know whether there is some fee agreement in place. Some of these people are simply touted by others because they may or may not belong to certain groups/organizations/political affiliations/charities and are touting them simply due to this fact. Bear that in mind if you are managing someone’s retirement account.   

One day I am going to mock up a hedge fund and create fictitious marketing agreements, fee structures and I will explicitly demonstrate how much of your return is diluted by various fee arrangements on a ficticious fund who passes on expenses.   

By Binish Bulsara


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