Hedge funds of funds (FOF) make investments in other hedge funds and with the goal of greater diversification. This type of investment style gains broad exposure to the hedge fund industry while diversifying the risk associated with one single fund. These funds will not make an investment in individual securities.
Hedge fund managers will invest with the view of selecting the best possible securities for their portfolio. A Hedge Fund of Funds manager will select actual hedge funds with the combination of the best performance and management.
Funds of funds will spend a lot of their time vetting and doing due diligence on the background of fund managers. The FOF’s will make sure the hedge fund managers they are investing with are qualified to manage money properly. Every investment manager will have his or her own style of investing, so it is important to do your homework. FOF will also spend a lot of time understanding what investments hedge funds are making, strategies being used, investment sizing, gross and net exposure, etc. Much of the due diligence process at these FOF have been under intense scrutiny as a result of the Bernie Madoff scandal.
Hedge Fund of Funds are typically regarded as less fundamental and quantitative as typical hedge fund’s because analysts at FOF’s not doing security analysis, they are diversifying capital across a variety of hedge funds.