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Fund Of Funds: Types, Advantages And Disadvantages
A FOF, or fund of funds, is a multi-manager investment fund investing in other types of funds.
In simple words, it is a funding portfolio that consists of different underlying portfolios of different other funds. These holdings may replace any investment that takes place directly through stock, bonds, or any other types of securities.
FOF generally invest in other hedge funds or mutual funds. They are usually classified as ?fettered,? or only able to invest in funds that are managed by the managing company of the fund of funds, or ?unfettered,? or incapable of investing in funds across the market.
Key Takeaways
- A fund of funds, or the FOF, is a collective fund that invests in other funds.
- A FOF usually invests in other mutual or hedge funds.
- The FOF concept aims to achieve a broader diversification and minimal risk.
- Fund of funds usually have a higher expense ratio compared to other regular mutual funds.
How Does A Fund Of Funds Work?
The FOF concept, aims to get a wider diversification and suitable asset allocation with investments in a wide range of funding categories that are all pooled under one single category.
Funds of funds have different types, and each of the types works on various investment schemes.
An FOF may be structured as a mutual fund, a private equity fund, a hedge fund, or an investment fund.
The fund of funds may either be flattered, which means it is only allowed to invest in portfolios that are managed by one investment company, or the FOF may be unfettered, which means it is allowed to invest in external funds that are handled by other managers from different companies.
Types Of Fund Of Funds
Some of the best funds that you can get in the market include the undermentioned categories.
Gold Funds
An investment made in different mutual funds, especially trading via gold instruments, is known as a gold fund. Based on the company?s asset management strategy, this category might have a portfolio of schemes or gold trading establishments themselves.
Asset Allocation Funds
These schemes consist of an assorted investment pool, with the securities containing precious metals, equity, and debt instruments. These funds attract high returns through best-performing securities and guarantee lesser risks due to the presence of stable instruments.
ETFs
An FOF mutual fund that has a portfolio that has exchange-traded funds is quite common, especially in countries like India. Investing in an ETF through a fund of funds is a lot more approachable compared to direct investments in these tools. This is because exchange-traded schemes require a special account, which in India is known as a Demat account while investing in an ETF via fund of funds will not oblige you to meet any such requirements.
Multi-Manager Fund Of Funds
This is the most popular type of fund of funds that you will find in the stock market. This asset base consists of professionally managed funds with multiple portfolio concentrations. These programs primarily have different managers, each of which handles a selective asset present within the fund of mutual funds.
International FOFs
These funds of funds particularly target those funds that are available in foreign countries. These schemes bring higher returns via the peak-performing stocks and bond guarantee services of the concerned country.
Advantages Of Fund Of Funds
Usually, an FOF attracts small-scale investors who look forward to getting better exposure with lesser risks in comparison to direct investment in securities and also in individual funds.
Investing in FOFs offers the investor professional money management expertise and services.
Investing in FOF also lets investors who have limited capital tap inside diverse portfolios that have different underlying assets. Multiple of these assets would otherwise be out of reach for an average retail investor. For instance, hedge funds usually require a minimum of a six-figure investment or the investors to have their own net worth – or both.
Most of the FOFs need a formal due diligence process for the fund managers – both the ones that belong to them and the ones looking after the underlying funds. The backgrounds of the applying managers are checked, which guarantees the background of the portfolio handler and their credentials within the securities industry.
Disadvantages Of Fund Of Funds
While a fund of funds offers diversification and minimal exposure to the volatile nature of the market, the returns that one receives may be considerably less as the investing fee is generally higher as compared to traditional investment funds. The higher fees are the result of the compounding fees on top of the fees.
Like other mutual funds, a FOF also has an annual operating expense, which is also known as the expense ratio, along with management fees and other operating costs.
However, FOF investors are likely to pay double as all the underlying funds within the FOF all have their annual fees and costs, too.
A fund of funds may charge an annual management fee that ranges between 0.5% to 1% to be able to invest in funds that may charge another 1% annual management fees. Therefore, the fund of funds investor, in total, is paying approximately 2%.
It is also a wonder that after you allocate all the money by investing in fees and other taxes, the returns that you get through fund of funds investment are typically lower as compared to the returns that a single manager fund can provide, even if the funds perform extremely well.
Also, picking up an efficient fund manager and fund is indeed a difficult task, particularly if the FOF is fettered. The fund of funds might end up owning the exact same stock or security via multiple different funds. This in turn reduces the actual diversification that investors look for.
Pros Of Fund Of Funds
- These are the top options when it comes to diversification.
- Expertise in professional management.
- Lesser chances of risk and volatility.
- Asset exposure is generally beyond small-scale investors.
Cons Of Fund Of Funds
- There are multiple layers of fees that are associated with FOFs.
- There is always a risk of holding overlap.
- There is a major difficulty in finding efficient funds or qualified managers.
The Bottom Line
Fund of funds offer investors benefits from their passive investments and exposure to index funds and diversification and ETFs. Additionally, a well-informed fund house monitors the fund of funds and generates a higher return through these strategies.
However, a fund of funds is always subject to market-related risks.
With that being said, a fund of funds offers returns of low risks because they invest in different mutual fund strategies.
Therefore, I would advise you to do proper research before you invest in a fund of funds.
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