A “fund of funds” (FoF) is an investment fund that uses an speculation strategy of holding a collection of other investment funds rather than investing directly in shares, bonds or other securities. This type of investing is often referred to as multi-manager speculation. There are different types of ‘fund of funds’, each investing in a different type of collective investment scheme, Mutual fund FoF, hedge fund FoF, private equity FoF or investment trust FoF. Some investment managers offering retail FoF may limit the fund selection to only contain the range of funds they manage; this type of understanding is called a fettered fund of funds. Most FoF offerings include funds from various investment managers and are called unfettered fund of funds.
Advantages: Investing in a collective investment scheme will increase diversity compared to a small investor holding a range of securities directly. Investing in a fund of funds arrangement will accomplish even superior diversification. An investment manager may aggressively manage your investment with a view to selecting the best securities. A FoF manager will try to select the best performing funds to invest in based upon the managers past performance and other factors. If the FoF manager is skillful, this additional level of selection can provide greater constancy and take on some of the risk relating to the decisions of a single manager. As in all other areas of investing, there are no guarantees.
Disadvantages: Management fees for funds of funds are typically higher than those on traditional investment funds because they include part of the management fees charged by the underlying funds. Since a fund of funds buys many different funds which themselves invest in many different securities, it is possible for the fund of funds to own the same stock through a number of different funds and it can be hard to keep track of the overall holdings. Funds of funds are often used when investing in hedge funds, as they usually have a high minimum investment level compared to traditional investment funds which precludes many from investing directly. In addition hedge fund investing is more complex and higher risk than traditional collective investments; this lack of convenience favors a FoF with a professional manager and built in spread of risk. Pension funds and other institutions often invest in funds of hedge funds for part or all of their “alternative asset” programs, i.e. investments other than conventional stock and bond holdings.
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