Fund Of Funds Of Funds, Oh My!

Mar 3 2006 | 1:00am ET

By Deirdre Brennan 

First there were hedge funds, then there were funds-of-hedge funds, and now, fund-of-fund-of-hedge funds have entered the alternatives space. While less than a dozen or so firms globally offer this type of product, most of them domiciled in Europe, one firm here in the U.S. has created a footprint in the industry with this unusual type of investment vehicle.

Last year, Gregoire Capital, which has trademarked the name F3, broke through what it calls the critical $500 million-mark in assets under management needed to attract institutional investors. It is now managing approximately $800 million in its multi-layered F3 funds, but it isn’t stopping there. In January, the firm launched an offshore version of its Tactical Equity Partners fund, which is designed to be a relative-return substitute for mid-cap and smallcap equities in a traditional portfolio with only half of the volatility.

Gregoire, which currently invests with U.S. fund managers, is also considering launching a European version of its F3 funds later this year.

“We are always trying to create new products,” said John Levitt, a principal at the firm, who is working to educate investors, especially institutional investors, about the benefits of what he calls “ultra-diversified” funds.

“Our (Tactical Equities Partners) fund is a perfect toehold investment for investors who have made a decision to invest in alternatives but don’t know where to begin,” he said, pointing out that institutional investors are very keen on low-volatility, which the onshore and the offshore versions provide.

Meanwhile, Gregoire’s flagship F3 product, DHS L.P., is designed to be a bond substitute and has nine investments that represent almost 500 underlying hedge funds. According to Levitt, out of those 500 underlying hedge funds, there is an 8% overlap in managers, however, 5% of those are funds that the firm wants to have overlap in.

As for fees, Levitt said his firm charges less than typical fund-of- funds. “Because of our size—we believe we are the largest private allocator to funds-of-funds in the United States—we have been able, in many cases, to negotiate discounts from stated fees,” he said. Although Levitt’s firm may be able to negotiate cut rates, not all fund-of-fund-of-funds managers are able to do so.

Richard Van Horne, ceo of Diversified Hedge Investment Advisors, which manages a fund-of-fund-of-hedge funds for Regent Atlantic Capital, said his fund charges three layers of fees, though he doesn’t doubt that firms with a large number of assets under management can negotiate lower fees and thus pass that along to their clients. “So fees are probably really somewhere between two to three layers,” he said.

Van Horne, who has $35 million in assets under management, said fund-of-fund-of-funds are a good choice for high-net-worth investors, including institutions, who want exposure to alternatives, but aren’t big enough to invest directly with hedge funds or fund-of-funds. For example, he said that someone with a $15-20 million portfolio would probably not be interested in the three-layer fund and instead would choose a fund-of-funds. However, he added that a three-layer fund does add diversification and reduce volatility, making it a good choice for a risk adverse investor.

Levitt disagrees with the premise that larger investors would not be interested in these types of funds, pointing out that sometimes institutional investors have money invested with multiple fund-of-funds, without regard to overlap. Van Horne said that people should not just look at the return, but also at how a three-layer fund can mitigate downside risk “Most people get freaked out when they find the value of their investment drops…but the kind of big drop that you could get when just owning stock, you are not going to get that when you invest in something like what I run or what John runs,” he said.

Meanwhile, Levitt added that another interesting feature of his F3 funds is that they are completely customizable. “The product is extremely customizable for end users because of the depth of data we have in the fund-of-funds universe,” he said. “We are able to construct F3 funds to replicate, to some degree or another, virtually any index that may be the targeted index for the institutional investor.”

However, Levitt doesn’t want people to confuse his fund with investable indices, which he said are similar to his F3 offerings in that they provide diversity, but are fundamentally different because investable indices are not actively managed. “In our view, there is very little place in an industry that is defined by active management for a passively managed index,” said Levitt.

Whether we will see more fund-of-funds-of-funds in the future remains to be seen. Van Horne doesn’t think there will be much of an increase in three-layer offerings, though Levitt is determined to win over the institutional market. “The goal is to make the marketplace more aware of this product, and to show the institutional market how viable it is, especially against the investable index products,” Levitt said.

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