For Funds of Funds, Due Diligence Does Not Pay

This is interesting from the San Francisco Chronicle:

Investors, in the case of Madoff, were so blinded by the reputation and returns that they didn't dig deeper into how the place really worked. Some of that may have been a function of cost, [NYU professor of finance Stephen] Brown said.

Conservatively, due diligence costs between $50,000 and $100,000 per hedge fund, so the cost of performing due diligence on 10 funds for a fund of fund portfolio can reach $1 million. At the same time, most funds of funds charge a 1.5 percent management fee to investors. That means a $20 million fund of funds might bring in $300,000 in management fees, not enough to cover cost of due diligence, Brown said.