F3 funds: Emerging trend or marketing gimmick?

Critics say: Too much diversification

Dec 15, 2003 @ 12:01 am

By David Hoffman

A hedge-fund-of-funds-of-funds vehicle known as F3 funds is supposed to provide ultradiversification, but many fund experts say it is a preposterous idea that will never work.

The concept adds another level of expenses to hedge funds of funds, which are already expensive, critics say. And the value of what investors get for their money is dubious because too much diversification can be as damaging to returns as too little diversification, the critics add.

Despite such concerns, the idea may be gaining traction.

"It gives diversification and volatility that is appropriate," says George Lucaci, a managing director with Channel Capital Group Inc. in New York, which publishes HedgeFund.net, a hedge fund news and information service. "We believe that's one of the emerging trends."

Minimizing overlap

The term "F3 funds" is trademarked by Gregoire Capital LLC in Millburn, N.J., which has been offering two such funds for 11 years.

John Levitt, a principal with Gregoire, says other firms have become more interested in F3-fund-type products. He says the funds are a good idea because they are designed as a low-risk product that also provides returns that compare favorably with the equity markets'.

Officials at Gregoire were unavailable to talk about the performance of their funds. Mr. Lucaci, however, says the numbers he has seen from Gregoire are very competitive with the average hedge fund

of funds' performance. Gregoire's funds, which together have $400 million in assets, minimize risk by building a portfolio of non-correlated funds of funds that can include 150 to 200 managers, Mr. Levitt says.

Minimizing overlap between funds of funds is crucial to generating returns, and it is something individual investors can't be expected to do themselves, Mr. Levitt says.

Mr. Levitt admits he charges a "small level of fees at the F3 level," but he thinks they are justified by the additional research and due diligence Gregoire provides.

Critics aren't convinced anyone can make F3 funds work.

A hedge fund of funds of funds is just a marketing gimmick, says Robert Levitt, president of Levitt Capital Management LLC in Boca Raton, Fla., which oversees nearly $200 million in client assets.

The added diversification does nothing but "diversify away return," adds the latter Mr. Levitt, whose firm manages and uses hedge funds in client portfolios.

"It's absolute idiocy," James R. Hedges IV, president of LJH Global Investments LLC in Naples, Fla., says of the F3 funds.

But John Levitt insists Gregoire can diversify among non-correlated hedge funds of funds, ensuring a smooth stream of returns.

"What we have done is created the ultimate diversified vehicle - a sleep-well product," he says.

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