Fund of Funds Structures in Hong Kong: Legal Framework, Due Diligence, and Regulatory Considerations

Introduction

A fund of funds (FoF) is an investment vehicle that allocates its capital across a portfolio of underlying funds rather than directly into securities or other assets. By pooling investor capital and deploying it across multiple underlying managers, a fund of funds offers investors diversification across investment strategies, manager styles, and asset classes, with the convenience of a single investment vehicle and a professional allocation team.

Fund of funds structures are used across a range of asset classes, including hedge funds, private equity, real estate, and infrastructure. In Hong Kong, FoF vehicles are established using a variety of legal structures, and their distribution and operation are subject to the Securities and Futures Ordinance (SFO), the Securities and Futures Commission (SFC) licensing regime, and, for retail-focused products, the SFC's authorisation requirements.

This article provides a comprehensive guide to fund of funds structures in Hong Kong, covering their legal and structural foundations, regulatory requirements, fee considerations, due diligence obligations, and the key considerations for investors and managers.

What Is a Fund of Funds?

A fund of funds invests in other investment funds (the "underlying funds") rather than directly in securities, commodities, or other assets. The FoF manager's primary role is to select, monitor, and rebalance the portfolio of underlying fund investments, applying manager selection expertise and portfolio construction skills to deliver returns to FoF investors.

The main categories of FoF in Hong Kong are:

Hedge fund of funds: Invests across a portfolio of hedge funds employing diverse strategies (long/short equity, global macro, arbitrage, credit, etc.), seeking to reduce single-manager risk and provide smoother return profiles.

Private equity fund of funds: Allocates commitments across multiple private equity funds (buyout, venture capital, growth equity), providing investors with diversified exposure to private equity across vintages, geographies, and sectors.

Multi-asset FoF: Invests across a mix of fund types (equities, bonds, alternatives), often structured as retail-accessible products providing a diversified investment solution in a single package.

Venture capital FoF: Allocates to early-stage and venture-focused funds, typically offered to institutional investors or sophisticated individual investors seeking exposure to startup ecosystems across multiple geographies.

Legal Structures for Hong Kong FoF Vehicles

Unit Trust

The unit trust is the most common structure for SFC-authorised retail FoF products in Hong Kong. The trust is managed by a management company and administered by a trustee. Investors hold units in the trust and are entitled to redemption of their units at NAV on prescribed dealing dates. Unit trust FoF structures must comply with the SFC's Code on Unit Trusts and Mutual Funds, including the requirements applicable to FoF specifically.

Open-Ended Fund Company (OFC)

Since the introduction of the OFC regime, some FoF products have been structured as OFCs rather than unit trusts. OFCs offer the advantage of corporate form, sub-fund segregation, and a modern governance framework, and are eligible for the Hong Kong profits tax exemption. OFC FoF products must comply with the Code on Open-Ended Fund Companies.

Limited Partnership Fund (LPF)

Private equity FoF are frequently structured as Hong Kong Limited Partnership Funds (LPFs) or Cayman Islands limited partnerships. The LPF structure is well-suited to the capital commitment model typical of private equity FoF, where investors commit capital upfront and the manager calls capital as it is deployed into underlying funds. LPFs enjoy Hong Kong's profits tax exemption for qualifying transactions.

Cayman Islands Structures

Many hedge fund FoF and private equity FoF accessible to Asian investors are domiciled in the Cayman Islands, using exempted company or limited partnership structures. These vehicles are typically distributed in Hong Kong to professional investors under the SFO's private placement exemptions, without SFC authorisation.

Regulatory Framework

SFC Authorisation for Retail FoF

A FoF offered to the public in Hong Kong must be authorised by the SFC under the SFO. The SFC's authorisation requirements for FoF include specific conditions relating to:

• Underlying fund requirements: The FoF must invest in eligible underlying funds, typically funds that are themselves SFC-authorised or regulated in jurisdictions with investor protection standards comparable to Hong Kong
• Investment restrictions: Limits on concentration in any single underlying fund (commonly 30% of the FoF's NAV), restrictions on investing in funds managed by the FoF's own manager or its affiliates without appropriate governance safeguards
• Fee disclosure: Disclosure of the layered fee structure (see below) and an overall fee cap or disclosure mechanism
• Redemption rights: The FoF must offer investors regular redemption rights consistent with the FoF's own liquidity profile and the liquidity of the underlying funds

SFC Licensing for FoF Managers

A manager of a FoF in Hong Kong must be licensed by the SFC for Type 9 (asset management) regulated activity. Where the FoF is publicly offered, the manager must also comply with the SFC's conduct requirements for licensed intermediaries, including disclosure obligations, conflict of interest management, and client suitability assessment.

Professional Investor FoF

FoF offered only to professional investors (as defined in the SFO) are not required to obtain SFC authorisation but must still be managed by a licensed manager. The professional investor exemption provides greater flexibility in investment strategy, fee structure, and disclosure.

The Layered Fee Structure

One of the most discussed aspects of FoF investing is the layered fee structure: FoF investors pay fees at two levels — the FoF level (management fee and performance fee charged by the FoF manager) and the underlying fund level (management fee and performance fee charged by the underlying managers). This "double layer" of fees can significantly erode net returns.

Typical FoF fee structures include:

FoF management fee: Commonly 1% of NAV per annum (compared to 1.5–2% for direct hedge fund investments).

FoF performance fee: Commonly 5–10% of profits above a hurdle rate (compared to 20% for direct hedge fund investments).

Underlying fund fees: In addition to the FoF-level fees, the underlying funds charge their own management and performance fees (typically 1.5–2% and 20% for hedge funds; 1.5–2% management fee and 20% carried interest for private equity).

In aggregate, the total fee drag on a FoF investment can be substantial — sometimes exceeding 3% of assets annually on an ongoing basis, plus performance fees at both levels. Fee transparency and the net return after all fees are critical factors in evaluating FoF investments.

Some institutional FoF managers have been able to negotiate fee reductions at the underlying fund level, passing part of the benefit on to FoF investors through reduced all-in fee structures or fee rebates.

Due Diligence for FoF Managers

The FoF manager's primary value proposition is the quality of its manager selection and due diligence processes. Key elements of FoF-level due diligence include:

Quantitative analysis: Track record analysis, risk-adjusted return metrics, correlation analysis, and performance attribution for potential underlying funds.

Qualitative due diligence: In-depth interviews with the underlying fund's investment team, assessment of investment process, portfolio construction, risk management, and organisational stability.

Operational due diligence (ODD): Assessment of the underlying fund's back office, fund administration, valuation processes, custody arrangements, compliance function, and conflicts of interest. ODD has become increasingly rigorous following high-profile fraud cases in the hedge fund industry.

Legal and regulatory review: Review of the underlying fund's constitutional documents, regulatory status, and legal compliance history.

Ongoing monitoring: Continuous monitoring of underlying fund performance, risk metrics, personnel changes, and operational developments after initial investment.

Disclosure Requirements

FoF operating in Hong Kong are subject to disclosure requirements under the SFC's regulatory framework, including:

• Offering documents must clearly describe the FoF structure, its investment strategy, the universe of permissible underlying funds, and the fee structure at both levels
• The risks of FoF investing, including liquidity risk (particularly where underlying funds have lock-ups or gates), manager selection risk, and fee drag, must be prominently disclosed
• Conflicts of interest, including any arrangement under which the FoF manager receives benefits from underlying fund managers (e.g., rebates, soft dollar arrangements), must be disclosed

Advantages and Disadvantages of FoF Investing

Advantages

• Diversification across managers, strategies, and asset classes, reducing single-manager risk
• Access to underlying funds that may be closed to new direct investors, given the FoF manager's established relationships
• Professional manager selection and portfolio construction expertise
• Simplified administration: a single investment and reporting relationship rather than managing multiple underlying fund subscriptions
• Suitable for investors who lack the resources to conduct direct fund due diligence

Disadvantages

• Layered fee structure erodes net returns
• Reduced transparency into underlying portfolio positions
• Liquidity may be more restricted than direct hedge fund investments if underlying funds have lock-ups or gates
• Dilution of alpha: diversification across many managers can result in returns that resemble a market index minus fees

How Alan Wong LLP Can Help

Our investment funds practice advises FoF managers, investors, and promoters on all aspects of establishing and operating fund of funds structures in Hong Kong. We advise on structural design, SFC authorisation applications, offering document preparation, investment management and custody agreements, subscription and redemption mechanics, and ongoing regulatory compliance. We also advise institutional investors on their FoF investments, including due diligence legal review and investor rights under FoF documentation.

If you are considering establishing a fund of funds or investing in one, please contact our team for a confidential discussion.