What is a 'Fund Of Funds'

A fund of funds (FOF) - also referred to as a multi-manager investment - is an investment strategy in which a fund invests in other types of funds. This strategy invests in a portfolio that contains different underlying assets instead of investing directly in bonds, stocks and other types of securities.

BREAKING DOWN 'Fund Of Funds'

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 fund. These are fund of funds characteristics that attract small investors who want to get better exposure with fewer risks compared to directly investing in securities. However, if the fund of funds carries an operating expense, investors are essentially paying double for an expense that is already included in the expense figures of the underlying funds. Historically, a fund of funds showed an expense figure that 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).

Fund of Funds Advantages

Investing in a FOF gives the investor professional financial management services. This experience allows the investor to test investing in professionally managed funds before they take on the challenge of going for individual fund investing. Most FOFs require a formal due-diligence procedure for their fund managers. Applying managers' backgrounds are checked, which ensures the portfolio handler's background and credentials in the securities industry.

Investing in an FOF also allows investors with limited capital to tap into diversified portfolios with different underlying assets, which are hard to access through individual investment.

Things to Consider Before Investing in Fund of Funds

Though FOFs provide diversification and less exposure to market volatility in exchange for average returns, these returns may be lessened by investment fees that are typically higher compared to traditional investment funds. These investment and management fees include all the fees charged by the portfolio's underlying funds. 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.

Fettered Management vs Unfettered Management

There are different kinds of FOFs, with each type acting on a different investment scheme. An FOF may be a mutual fund, a hedge fund, a private equity or an investment trust. An FOF may be fettered, which means that it only invests in portfolios containing assets and funds managed by one investment company. It may also be unfettered, which means that it invests in external funds controlled by other managers from other companies.

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