Do Funds-of-Funds Deserve Their Fees-on-Fees?

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Abstract
Since the after-fee returns in funds-of-funds are, on average, lower than hedge fund returns, it appears that funds-of-funds do not add value. However, we show that funds-of-funds should not be evaluated relative to hedge fund returns from reported databases. Instead, the correct fund-of-funds benchmark is the return an investor would achieve from direct hedge fund investments on her own without recourse to funds-of-funds. We use certainty equivalent concepts and revealed preference arguments to estimate attributes of the true, implied true fund-of-funds benchmark distribution. Since the benchmark characteristics seem reasonable, we conclude that, on average, funds-of-funds deserve their fees-on-fees.

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