Fund of funds (FOFs) have become an increasingly popular investment vehicle over the last couple of decades. As the name suggests, a FOF is a fund that invests in multiple underlying funds instead of investing in bonds, stocks, or other securities directly. This provides investors with instant diversification across various asset classes, investment styles, and fund managers. But like any investment strategy, FOFs have their own pros and cons. In this article, we will explore what exactly FOFs are, their benefits for investors, and whether they are ultimately worth investing in.
What Are Fund of Funds?
An investment fund known as a FOF holds a portfolio of other investment funds as opposed to making direct investments in specific stocks. A FOF can have actively managed index funds, hedge funds, mutual funds, real estate funds, private equity funds, and more as its underlying funds. Investment diversification with precious metals.
FOFs allow investors to achieve broad diversification with a single investment. The FOF manager selects, monitors, and allocates capital across the various underlying funds. This provides exposure to multiple asset classes, fund managers, investment styles, and market sectors. FOFs aim to achieve strong risk-adjusted returns over the long run by blending together varied investment strategies.
Benefits Of Investing In Fund of Funds
There are several notable benefits that make FOFs an appealing investment vehicle for many investors:
- Instant Diversification: Rather than building a portfolio fund-by-fund, fund of funds for real estate investing offers diversification across asset classes, fund managers, and investment strategies in one simple investment. This reduces portfolio risk.
- Professional Management: FOF managers conduct thorough due diligence on underlying funds and allocate capital based on research and experience. This can be beneficial for investors who lack the time or expertise to select their own funds.
- Lower Investment Minimums: Since the FOF pools money from many investors, the minimum investment required is often lower than the minimum required for investing directly in the underlying funds. This allows more investors to access top-tier funds.
- Simplified Portfolio Management: Rather than monitoring and rebalancing multiple funds themselves, investors can rely on the FOF manager to handle this. The FOF structure makes portfolio oversight simpler.
- Access To Exclusive Funds: FOFs sometimes provide access to funds or investment managers that aren’t available to average retail investors. Hedge funds and private equity funds, for example, often have high minimums and other investor requirements.
Potential Downsides To Consider
While they offer many benefits, FOFs also come with some drawbacks to consider:
- Multiple Layers Of Fees: Investors pay the FOF’s management fee in addition to the management fees charged by each underlying fund. This can result in higher total costs compared to investing in funds directly.
- Less Control: Investors have less visibility and control over the specific assets held compared to investing directly. The FOF manager handles all allocation decisions.
- Performance Drag: The diversification and asset allocation of FOFs may water down returns compared to concentrated approaches during certain market environments. The FOF structure can become a performance drag in itself.
- Liquidity Constraints: Some FOFs have less liquidity compared to traditional mutual funds since they invest in funds like hedge funds and private equity that have lock-up periods and redemption restrictions. This reduces flexibility.
Weighing The Pros and Cons
There are good reasons on both sides of the debate regarding FOFs. For many investors, the diversification, professional management, and convenience benefits outweigh the higher costs and reduced control. But FOFs are certainly not right for every investor or investment goal. As with any fund, it’s critical to analyze the strategy, performance track record, costs, manager experience, and your own needs before investing.