In a bleak period for the financial industry, hedge funds stood out as one of the few growth businesses. Hoping to obtain absolute returns that are uncorrelated with broader stock market movements, while further diversifying their portfolios, institutional investors embraced this alternative asset class. However, as the number of hedge funds has burgeoned so did the challenge of investing in them. Typically cautious, institutional investors have been loath to leap into an area outside their core competences and started turning to a group of intermediaries known as fund-of-hedge-funds managers, such as PAAMCO, that specialize in identifying the best hedge fund managers for their clients. The case explores the issues faced by fund-of-hedge-funds managers when selecting the hedge funds to build either standardized funds or custom portfolios for their clients. In a broader sense the case provides for discussions on what hedge funds are, what investment strategies they use and who their investors are as well as exploring the general aspect of asset pricing portfolio theory.
