What Is a Fund of Funds (FOF)?
A fund of funds (FOF)—also known as a multi-manager investment—is a pooled investment fund that invests in other types of funds. In other words, its portfolio contains different underlying portfolios of other funds. These holdings replace any investing directly in bonds, stocks, and other types of securities.
FOFs usually invest in other mutual funds or hedge funds. They are typically classified as "fettered," or only able to invest in funds managed by the FOF's managing company, or "unfettered," or able to invest in funds across the market.
Key Takeaways
- A fund of funds (FOF) is a pooled fund that invests in other funds.
- FOFs usually invests in other hedge funds or mutual funds.
- The fund of funds strategy aims to achieve broad diversification and minimal risk.
- Funds of funds tend to have higher expense ratios than regular mutual funds.
How a Fund of Funds (FOF) Works
The fund of funds (FOF) strategy aims to achieve broad diversification and appropriate asset allocation with investments in a variety of fund categories that are all wrapped into one portfolio.
There are different kinds of FOFs, with each type acting on a different investment scheme. A FOF may be structured as a mutual fund, a hedge fund, a private equity fund, or an investment trust. The FOF may be fettered, meaning it only invests in portfolios managed by one investment company. Alternatively, the FOF can be unfettered, letting it invests in external funds controlled by other managers from other companies.
Fund of Funds Advantages
Typically, FOFs attract small investors who want to get better exposure with fewer risks compared to directly investing in securities—or even in individual funds. Investing in a FOF gives the investor professional wealth management services and expertise.
Investing in a FOF also allows investors with limited capital to tap into diversified portfolios with different underlying assets. Many of these would be out-of-reach for the average retail investor. For example, hedge funds typically require six-figure minimum investments or require investors to have a minimum net worth—or both.
Most FOFs require a formal due-diligence procedure for their fund managers—both their own and those managing the underlying funds. Applying managers' backgrounds are checked, which ensures the portfolio handler's background and credentials in the securities industry.
Fund of Funds Disadvantages
Though FOFs provide diversification and less exposure to market volatility, these returns may be lessened by investment fees that are typically higher than traditional investment funds. Higher fees come from the compounding of fees on top of fees.
Like most mutual funds, a FOF carries an annual operating expense—known as the expense ratio—as well as management fees and operating costs. However, FOFs investors are essentially paying double—because the underlying funds in the FOF all have their annual costs and fees, too.
In the past, funds of funds' prospectuses didn't always include the fees of the underlying funds. As of January 2007, the SEC began requiring that these fees be disclosed in a line called Acquired Fund Fees and Expenses (AFFE).
A fund of funds might charge annual management fees of 0.5% to 1% to invest in funds that charge another 1% annual management fee. So, the FOF investor in sum is paying up to 2%. Small wonder that, after allocating the money invested to fees and other payable taxes, the returns of fund of funds investments may generally be lower compared to the profits that single-manager funds can provide—even if the funds perform very well.
Picking good fund managers and funds can be difficult, too—especially if the FOF is fettered. The FOF may end up owning the same stock or other security through several different funds, thus reducing the actual diversification.
Pros
Ultimate in diversification
Professional management expertise
Alleviation of risk and volatility
Exposure to assets usually beyond small investors
Real-World Example for Fund of Funds
Since they are so varied, funds of funds can be hard to track as a group and to compare. However, an index does exist. The Barclay Fund of Funds Index, sponsored by Barclay-Hedge, a provider of data on alternative investments, is a measure of the average return of all FOFs that report into the company database. Through Q1 2022, for instance, 156 funds of funds had yielded an average return of 0.33% year-to-date. The S&P 500 during the same period lost more than 7.5%.
Are Funds of Funds Common?
Dedicated funds of funds may be less common that standalone mutual funds or ETFs. However, the SEC estimates that approximately 40% of all registered funds hold an investment in at least one other fund.
How Much Assets Are Invested in Funds of Funds?
According to the SEC, Total net assets in mutual funds that invest primarily in other mutual funds reached over $2.54 trillion in 2019.
Are Funds of Funds Regulated by the SEC?
Yes, like all other pooled investment products, FOF are also overseen by the SEC. In particular, SEC Rule 12d1-4, updated in 2020, sets out procedures that provide a consistent framework for fund of funds arrangements. The SEC also requires FOFs to disclose their fees in a transparent manner.
FAQs
Though FOFs provide diversification and less exposure to market volatility, these returns may be lessened by investment fees that are typically higher than traditional investment funds. Higher fees come from the compounding of fees on top of fees.
What is an example of a fund of funds? ›
A FOF aims at diversifying the risk of a single fund by investing in several types of funds. An investor with limited capital can invest in one FOF and get a diversified portfolio consisting of, for example, bonds, gold, equity, and debt.
What are the pros and cons of mutual funds explain? ›
Mutual funds have pros and cons like any other investment. One selling point is that they allow you to hold a variety of assets in a single fund. They also have the potential for higher-than-average returns. However, some mutual funds have steep fees and initial buy-ins.
What are the pros and cons of money market funds? ›
Money market funds have benefits such as diversifying your investment portfolio and providing regular income payments. But your money won't be federally insured and you may incur fees.
What are the benefits of fund of funds? ›
Benefits of a Fund of Funds
Whereas owning one mutual fund reduces risk by owning several stocks, an FOF spreads risk among hundreds or even thousands of stocks contained in the mutual funds it invests in. FOFs also provide the opportunity to reduce the risk of investing with a single fund manager.
What are the three advantages of the fund of funds? ›
Portfolio diversification, access to top-tier venture capital firms that may not be available to individual investors, and professional advice and portfolio management services are all potential benefits of a fund of funds.
What are the problems with fund of funds? ›
Costs are a big issue because each fund contained in a fund of funds has a separate fee to pay those managers, and there's a fee to own the fund itself.
What is the typical fee for a fund of funds? ›
Funds of funds structure and fees
The FoF charges investors a fee on top of the individual funds, which is similarly structured, though lower. A typical FoF fee would be “1 and 5”, which means a 1% management fee on your investment plus a 5% performance fee on the gains from the investment.
How does a fund work? ›
When you invest in a fund, your and other investors' money is pooled together. A fund manager then buys, holds and sells investments on your behalf. All funds are made up of a mix of investments – this is what diversifies or spreads your risk.
What is the dark side of mutual funds? ›
Mutual funds come with many advantages, such as advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing. Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
Managed by Experts: Unlike standalone securities, mutual funds are managed by experts, so they are considered safe and secure. 3. Diversity: Based on the theme and category of mutual funds, investors get the exposure to a large number of stocks across the market capitalisation spectrum.
Why people don t invest in mutual fund? ›
As the funds are invested in market instruments, they carry certain stock market risks like volatility, fall in share prices etc., which deters us from investing in mutual funds. As we don't want to lose money, we often let it stagnate in our savings accounts.
How much will $10000 make in a money market account? ›
A money market fund is a mutual fund that invests in short-term debts. Currently, money market funds pay between 4.47% and 4.87% in interest. With that, you can earn between $447 to $487 in interest on $10,000 each year. Certificates of deposit (CDs).
Is my money safe in a money market fund? ›
The Bottom Line
Both money market accounts and money market funds are relatively safe, low-risk investments, but MMAs are insured up to $250,000 per depositor by the FDIC and money market funds aren't.
Are money market funds safe in a recession? ›
When the stock market is extremely volatile, and investors aren't sure where to invest their money, the money market can be a safe haven for it while they decide where to put it to use. Why? As stated above, money market funds are often considered less risky than their stock and bond counterparts.
Is it good to invest in fund of funds? ›
Ideally, investors with relatively fewer resources and low liquidity needs can choose to invest in the top fund of funds available in the market. This enables them to earn maximum returns at minimal risk.
What is the advantage of investing in a fund of mutual funds? ›
Low Cost — An important advantage of mutual funds is their low cost. Due to huge economies of scale, mutual funds schemes have a low expense ratio. Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund's daily net assets.
What are 5 cons of investing? ›
While there are some great reasons to invest in the stock market, there are also some downsides to consider before you get started.
- Risk of Loss. There's no guarantee you'll earn a positive return in the stock market. ...
- The Allure of Big Returns Can Be Tempting. ...
- Gains Are Taxed. ...
- It Can Be Hard to Cut Your Losses.
Funds of hedge funds typically charge an additional layer of fees. In addition to the fees charged by the underlying hedge funds, funds of hedge funds add an extra layer of management and/or performance fees, which can reduce returns compared to investing directly in the same underlying hedge funds.
