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Dec 2010

Yale University endowment manager David Swensen launched a blistering broadside at the practices institutional investors use to select hedge funds in an interview last year with the Wall Street Journal.

Swensen described fund of hedge funds as "a cancer on the institutional investor world. They facilitate the flow of ignorant capital." His argument was that such funds are self-defeating; investors need to be in the top 10% of hedge funds to succeed and, with a fund of funds, they are likely to be excluded from the best managers.

He was equally withering about the practice of fund managers and consultants only channelling funds to a short approved list of hedge funds: "Consultants make money by giving advice to as many people as possible. But you outperform by finding inefficiencies most of the market has not yet uncovered. So consultants ultimately end up doing a disservice to investors."

But was Swensen's criticism justified? And if so, is there anything that schemes can do to avoid these pitfalls?

If his critique of fund of hedge fund (FoHF) managers was the complete story, there would be little point choosing this route to investment. However, these managers, offering investors access to a portfolio of hedge funds in a single investment fund, represents a wholly different risk profile to investing with a single hedge fund manager and may be more suitable for some schemes.

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