Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

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Which of the following is NOT a disadvantage of multistrategy hedge funds compared to funds of hedge funds?

  1. Funds of hedge funds can achieve a greater level of diversification.

  2. Multistrategy hedge funds cannot achieve the same diversification of manager and operational risks.

  3. Multistrategy hedge funds have a significantly higher fee structure.

  4. Manager selection is not a source of return for multistrategy hedge funds.

The correct answer is: Multistrategy hedge funds have a significantly higher fee structure.

The chosen answer highlights that multistrategy hedge funds do not inherently possess a significantly higher fee structure compared to funds of hedge funds. In reality, both types of funds can have varied fee structures based on their investment strategies, management styles, and specific fund operations. Funds of hedge funds typically charge a two-tier fee system: one for the fund of funds itself, which can include management and performance fees, and another for the underlying hedge funds in which they invest. This layered fee structure can lead to higher overall fees when compared to single multistrategy hedge funds, which may have more straightforward fee arrangements. Understanding the fee dynamics is crucial in evaluating the total cost of investment in these fund types. While fund managers may charge high fees for their expertise, the nature of multistrategy hedge funds allows for potential cost efficiencies not found in funds of hedge funds. On the other hand, multistrategy hedge funds face disadvantages such as challenges in diversification and manager selection. While they may employ various strategies, these funds are often concentrated under a unified management team, which could limit exposure to diverse investment approaches compared to funds of hedge funds that spread investments across multiple external hedge fund managers. This structure can impede multistrategy funds' ability to mitigate manager or operational risks

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