How does a fund-of-funds structure work and what are its fee layers?

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AcadiFi · Accepted Answer

A fund of hedge funds (FoHF) invests in a portfolio of underlying hedge funds. Investors gain diversification across managers and strategies, access to closed funds...

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Fee structure: (1) Underlying funds charge 1.5-2% management plus 15-20% performance. (2) FoHF wrapper adds another 0.5-1.5% management plus 5-10% performance. (3) Blended expense ratio frequently lands at 3-4% management plus effective 22-28% performance.

At Bramwell: $50M allocation to a FoHF charging 1%/10% over a 7% hurdle, invested across 18 hedge funds averaging 1.8%/18%. In a year where underlying gross returns are 12%: underlying net to FoHF is approximately 12% - 1.8% - 0.18*(12% - hurdle) which equals roughly 8.7%. The FoHF then charges 1% management plus 10% above 7% hurdle: net to Bramwell is about 7.5%. A 450 bps friction between gross alpha and investor return.

Benefits nonetheless: operational due diligence, access to capacity-constrained managers, cross-fund diligence economies, and institutional-quality monitoring. For smaller allocators without in-house DD capabilities, that value proposition can justify the fee drag.

For AcadiFi CFA candidates: memorize the fee-layering math. Also understand that FoHF share classes frequently have lock-ups or gates mirroring underlying funds, and some include founder share classes with reduced fees. Post-Madoff, operational DD by FoHFs has materially improved but has never been a substitute for the LP's own verification.

How does a fund-of-funds structure work and what are its fee layers?

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