Fund of funds

A "fund of funds" (FoF) is an investment fund that uses an investment strategy of holding a portfolio 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 investment.

There are different types of 'fund of funds', each investing in a different type of collective investment scheme (typically one type per FoF), eg. 'mutual fund' FoF, hedge fund FoF, private equity FoF or investment trust FoF.

Features

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 achieve even greater diversification.

An investment manager may actively 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 stability 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 for regular returns.

Considerations

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 several different funds and it can be difficult to keep track of the overall holdings.

Funds of funds are often used when investing in hedge funds and private equity funds, as they typically have a high minimum investment level compared to traditional investment funds which precludes many from investing directly. In addition hedge fund and private equity investing is more complicated and higher risk than traditional collective investments. The lack of accessibility 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 traditional stock and bond holdings.

Private equity fund of funds

According to Private Equity Intelligence, in 2006 funds investing in other private equity funds (i.e., fund of funds, including secondary funds) amounted to 14% of all committed capital in the private equity market. The following ranking of private equity fund of fund investment managers is based on information published by Private Equity Intelligence:

"Source: Private Equity Intelligence" [ [http://www.prequin.com/backend/LP_LeagueTables.aspx Private Equity Intelligence LP Leage Tables] . Based on analysis provided by Private Equity Intelligence an independent provider of private equity data and information. "Private Equity Fund of Funds Managers, Located Anywhere, Data for Capital Currently Committed to PE]

Fund of hedge funds

A fund of hedge funds is a fund of funds that invests in a portfolio of different hedge funds to provide broad exposure to the hedge fund industry and to diversify the risks associated with a single investment fund. Funds of hedge funds select hedge fund managers and construct portfolios based upon those selections. The fund of hedge funds is responsible for hiring and firing the managers in the fund. Some funds of hedge funds might have only one hedge fund in it, thus lets ordinary investors into a highly-acclaimed fund, or many hedge funds.

Funds of hedge funds generally charge a fee for their services, always in addition to the hedge fund's management and performance fees, which can be 1.5% and 15-30%, respectively. Fees can reduce an investor's profits and potentially reduce the total return below what could be achieved through a less expensive mutual fund or ETF.

While funds of funds conceptually can provide extremely useful services for many hedge fund investors, they have been criticised for the significant incremental costs they impose. (The underlying hedge funds usually charge fees of between 1 and 2% of assets managed and incentive fees of 15–25% of profits generated. The funds of funds typically add additional fees of 1% and 10%, respectively). Moreover, fund-of-funds behavior has often exhibited crowd-following tendencies, suggesting the managers of these funds prefer to match indices rather than seek opportunities.

The industry has recently been criticized by some hedge fund managers for a reputation of holding a short-term view. Some hedge funds have even started turning away fund of hedge funds money. “It is really beginning to irritate those funds of hedge funds that approach their investments sensibly,” says one fund of hedge funds manager. [cite web
url=http://www.euromoney.com/article.asp?ArticleID=1083631
title=The funds of hedge funds that are too hot to handle.
publisher=Euromoney magazine
date=Nov. 2006]

Other examples

*Vanguard STAR is a popular U.S. mutual fund that invests in other Vanguard mutual funds. Assets include U.S. and non-US stock funds, long and short-term bond funds, a GNMA fund, and a money market fund. The fund itself does not have any fee.

*A similar one is "Vanguard Life Strategy Moderate Growth", which invests in four other Vanguard funds, and again has no fee itself.

ee also

*Collective investment schemes
*Investment management
*Manager of managers fund

References

*" [http://www.altassets.com/casefor/sectors/2003/nz3258.php Private equity fund of funds] ." AltAssets, 08/01/2003
* [http://www.altassets.com/pdfs/FW-280-0609.pdf Investing in Private Equity through a Fund of Funds]
* [http://www.altassets.com/pdfs/piper_jaffray2004.pdf ALTERNATIVE ASSETS—PRIVATE EQUITY FUND OF FUNDS]