The FSA has published rules funds of alternative investment funds must abide by.
The regulator also published an extensive list of questions intermediaries must be able to answer before they can recommend the new retail product to their clients.
The Investment Management Association welcomed the FSA's move, saying "it enables investors to gain access to a wider range of investments."
The FSA will review the rules after implementation, and did not rule out re-writes of them once the EU's Alternative Investment Fund Management directive takes effect later this year.
Under the proposed framework, Faif managers will be allowed to invest up to 100% of assets in funds, including on- or offshore hedge funds.
The Faif's manager can wait 185 days before paying redemptions, but they must explain redemption procedures clearly to investors.
The FSA has imposed stringent due diligence obligation on Faif managers, including ensuring the funds they invest in have their property held by an independent third party.
"This may limit the eligibility of some underlying schemes in the short term, [but] we believe this is important in order to protect investors," the FSA says.
Investee funds must have their NAVs struck and accounting records kept independently of the investment management function.
Faif gearing will be limited to 10%. The FSA says: "High borrowing levels can result in increased risk."
Speaking to the IFA audience, the FSA adds: "Intermediaries should consider not only their own understanding of the issues concerned, but also how they can explain [these] to their client in an appropriate manner.
"An intermediary should not distribute a product if they do not understand it sufficiently."
An IFA should understand the prospectus and risks being taken by the Faif; due diligence the Faif's manager does on underlying funds; how the Faif differs from other investments or funds; how it will be taxed; and where it will invest.
The IFA should also know if the Faif uses gearing, how diversified it will be and how it should perform in different market conditions, among a raft of other matters.
