Lesson 8 of 8 · 12 min
Funds of funds, benchmarks and index biases
A fund of funds adds a second layer of fees on top of the underlying funds' fees, and hedge fund indexes overstate typical returns because failed funds drop out and only winners get backfilled.
In short
- A fund of hedge funds (FoHF) charges its own fees (e.g. '1 and 10') on returns already net of the underlying funds' fees: the double layer of fees.
- Investors accept it for due diligence, diversification and access to funds closed to new money.
- Benchmarks for private equity and real estate work best when funds are compared with peers of the same vintage year.
- Survivorship bias: indexes that drop failed funds look too good.
- Backfill bias: funds added later with their (good) past track record push historical index returns up.
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