Fund-of-Funds Model is 'Broken'? That Negates the Whole Point

New York lawyer Eric Roper, in Friday’s Wall Street Journal

The fund-of-funds model is good when it's working, but I think now for many funds it's broken, at least temporarily.

Now he tells us. The whole point of fund of funds, I thought, was that the model was supposed to always work, no matter how extreme the environment became. The idea was that FofF managers would vet the ablest hedge fund managers they could identify, and then put together well-diversified portfolios that would provide attractive, balanced returns no matter what—even at times like now. In the event, it turns out that more than a few managers only did cursory due diligence, and gave the money to Bernie Madoff or some functional, non-crooked equivalent.

And the ones who did do the work they promised to do still ended up being hit by a wave of redemptions, and in turn redeemed their own investments more or less willy-nilly, at whatever manager could provide liquidity, regardless of performance--which in turn caused a cascade of random selling that only made things worse.

If FoFs added value this cycle, I don’t see it—and this was exactly the sort of cycle in which FofFs should have thrived. . . .

Comments

[morph366:]

Other than the inability of the fund managers to do their due diligence properly there is a more fundamental problem with the Fund of Funds concept. It exposes the severe limitations of the diversification model that was pioneered by Markowitz. In "normal" conditions one can exploit the fact that some asset prices will have low correlations with other asset prices, but In times of crisis the covariance across asset classes - or the co-movement of many asset prices - tends to converge on one as liquidity evaporates

Jan 11 11:41 AM

[joes:]

In these times there are no "winners" except for the lucky, diversification is still the only long term strategy that has the potential to provide returns over time since there is no level of due diligence that could have predicted the depth of the current situation.

Jan 12 09:55 AM