correlated in the future, then the investor needs to consider the "free ride" that will be enjoyed in not having to pay the performance fee to Hedge Fund A. The free ride occurs because the investor does not have to pay performance fees until Hedge Fund A's NAV returns to the high-water mark. Consequently, from the $800,000 NAV, the investor can receive a return of 25 percent without paying fees. In contrast, suppose the investor terminates Hedge Fund A and invests in Hedge Fund B, and that Hedge Fund B returns 25 percent gross. Assuming a performance fee of 20 percent, the investor receives only 20 percent net returns. Clearly, if Hedge Fund A and Hedge Fund B have identical gross returns over the next year, the net returns to Hedge Fund A will be higher than those to Hedge Fund B since no performance fee will be paid to Hedge Fund A. The implication of this is that there may be an incentive at the margin to not actively trade hedge funds. FUNDS OF HEDGE FUNDS For investors who do not have the resources or expertise to invest in a portfolio of hedge funds, there are funds of hedge funds. These investment firms may operate in one or all of the four hedge fund sectors outlined in Figure 27.2. A fund of funds may be able to obtain better access to information and to managers than may individuals investing on their own behalf. Funds of funds also offer the opportunity to invest in a diversified portfolio with a low minimum amount. Most hedge funds require a minimum investment of Si million. A fund of funds makes it possible for investors to have well-diversified hedge fund portfolios for lower investment amounts than would otherwise be the case. Finally, the fund of funds offers access to professional investment management, including manager evaluation, portfolio construction, and monitoring.