Fund of Funds - Explained
What is a Fund of Funds?
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Table of ContentsWhat is a Fund Of Funds?How Does a Fund of Funds Work?
What is a Fund Of Funds?
Fund of funds, also known as FOF, is a type of investment strategy where funds are invested in other funds or hedge funds, instead of investing it directly in bonds, stocks, or other securities. It has often been referred to as a multi-manager investment because it entails investing in funds where the same company manages it. It means that the investment can apply to external funds under the administration of other managers. The reason why some investors may prefer FOF is that it offers greater portfolio diversification and reduces volatility while it maintains average returns. It is different from retaining investors who directly hold a smaller range of securities. However, FOF comes with an additional fee that is paid at the FOF level as well as at the underlying investment fund level. FOF was established in 1962 by Bernie Cornfield but later went bankrupt after it was looted by Robert Vesco.
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How Does a Fund of Funds Work?
The main aim of the FOF strategy is to ensure that there is broad diversification as well as proper asset allocation when it comes to investments. It provides a number of fund categories for investments that are covered in one portfolio. Types of Funds of Funds exist in many forms, with each acting in a separate investment scheme. They include the following:
- Mutual fund
- Hedge fund
- Private equity
- Investment trust
FOF is termed as a manager picker. What this means is that under the pretense of increasing diversifications benefits, the FOF managers will choose other fund managers who are top performers and invest with them instead of managing the capital themselves. This strategy of spreading money across several managers is done with the hope that it will bring about greater diversification to benefit the client. However, this can only be great if the intended benefits actually happen.
- There is a diversification benefit for investors
- There is the professional management of funds by experts
- The investment applies to those investors will little amount
- There is greater exposure at a low cost
- Reduced risk and volatility
- The actual problem with these funds is that they tend to underperform compared to other diversified investments.
- There is an extra layer fee
- There is holdings overlapping risk
- Difficulty in finding qualified funds and managers