Goldman Sachs (GS) to launch private equity fund to invest in hedge funds

Recently, Goldman Sachs Group, Inc. (NYSE: GS) announced it plans to create a private equity fund that will buy stakes in hedge funds. That could be interesting because investors reap profits based on the management/performance fees earned by the fund manager rather than the fund's performance itself. But because any hedge fund's growth is tied to its performance, these investments likely amount to bets on the ability of certain hedge funds to earn strong returns. Fortress Investment Group, LLC (NYSE: FIG), the first hedge fund to offer shares of itself in the United States, has performed terribly since its IPO.

Part of the problem with investing in a hedge fund manager is that so much of the money is paid out as bonuses to the managers that serving as a passive investor may not be as lucrative as it seems.

Today's Wall Street Journal takes a look (subscription required) at another popular way to invest in hedge funds: funds of funds.

The problem with funds of funds is that it's a lot like paying a broker a 5% commission to find a great broker whom you can pay 5% to sell your house: It adds in a layer of costs, and it's very difficult to produce the performance to overcome the disadvantage created by the huge fees.

Still, these funds of funds are showing rapid growth but, long-term, I would be willing to bet that these funds will underperform a passively-managed index. Fees always matter.