Like most domestic hedge funds, fund of funds are organized as limited partnerships with a general partner who receives a management fee from the partners (investors of the fund) and an incentive allocation fee. However, the general partner does not make direct investments. The manager of a fund of funds invests its pooled capital in other hedge funds or investment vehicles that utilize a variety of investing styles and market segments. The principle is similar to that of a mutual fund whereby this type of investment vehicle provides an opportunity for the partners to establish a diversified alternative investment program at a substantially lower minimum investment than accessing each of the portfolio managers separately.
In addition to the fund of funds manager’s fees, it must be noted that in a fund of funds structure, the fund manager is taking on an extra layer of fees in exchange for a diversified exposure in its investment strategy.