A “fund of funds” is a term that refers to a portfolio consisting of mutual funds. The major advantage is that these types of portfolios can offer higher returns than individual stocks and bonds, due to the diversification factor. However, they also require large amounts of time and effort in maintaining them.
According to Fintalent’s Fund of Funds (FoF) consultants, FoFs are sometimes referred to as “funds of funds” because the portfolios consist of funds. This is because each portfolio within a FoF consists of a group of mutual funds, and each fund held within the FoF has its own investment strategy. As such, there is no single holding or investment style that dominates all other stocks and/or bonds held within the portfolio.
In short: mutual funds are portfolios which contain a large number of shares (and therefore shares to buy and sell). The asset allocation for these portfolios relates to the types and/or amount of assets contained within these portfolios. Each mutual fund holds different types of investments. By holding several different mutual funds within one portfolio, an investor is able to diversify their holdings without the complications of trying to construct a portfolio themselves. A FoF is merely a collection of these mutual funds.
Why invest in FoFs?
Investors make use of FoFs for many reasons, not least because they can be quite advantageous; these include the fact that they do not necessarily retain any specific investment style (i.e. there are no restrictions on what securities go into them), they may allow investors to spread assets across multiple investments, and they also allow investors to diversify their assets across different types of funds (such as stock or bond funds). These advantages over direct stock and bond investing may result in enhanced returns, which can eventually lead to higher net wealth for investors.
But FoFs are not without their drawbacks! To list only a few: they require more time, effort and skill than simple investment strategies, they generate high transaction costs (which may eat away at the potential return), the investor must establish custody accounts for each of the securities contained within the portfolio, many times there are limits on what types of mutual funds can be held within a portfolio, and they also occasionally attract higher management fees.
What are the types of FoFs?
The three types of FoFs are equity funds, balanced funds and bond funds. Equity FoFs form the most commonly traded FoFs. These are also referred to as “funds of funds” because they are composed of mutual funds.
Bond FoFs are essentially similar to equity FoFs in terms of investment strategy, but they have a different investment objective. Unlike equity FoFs, who generally consist of mutual funds whose holdings can be varied within the portfolio, bond FoFs usually hold nothing but bonds. This is because the purpose of these portfolios is to hedge against risk in various ways, which means that an investor should possess only securities that are highly unlikely to default on their principal repayment obligations. Therefore, bonds are usually more appropriate for this type of portfolio.
Balanced FoFs are usually referred to simply as “balanced funds”, and are commonly used by investors who wish to invest in both stocks and bonds. Most balanced funds include a mix of bonds and equities, but this is not always the case. Most balanced funds will also include cash equivalents, commodities, real estate securities, foreign securities, derivatives, or any other security type that an investor can find! The most common investment objective for balanced FoFs is capital preservation with growth.
Unlike other investment vehicles, fund of funds is typically short-term in nature: typically five years (sometimes as short as one year), and they generally don’t invest in value securities such as stocks because it is not always possible to know what the company will be worth just by looking at its financial statements. They also do not invest in corporate bonds or preferred shares, but rather invest in different types of bonds (fixed income).
Another reason for this is that there is a lot of liquidity in the market and bonds pay high yields. It can be difficult for investors to find firms that offer high interest rates, but bond issues are generally certain and liquid (and therefore less risky).
The fund usually has investments from different categories, such as equities or fixed income; it will also typically invest in a balanced portfolio by investing in both “good” assets (such as large and stable companies) and “bad” assets (such as small and unestablished companies).
FoF Vs Hedge Funds
A fund of funds differs from a hedge fund in several ways. A hedge fund is an investment vehicle that uses financial instruments such as derivatives to successfully manage risk.A hedge fund manager is a professional who manages the hedge funds.
A fund of funds, unlike a hedge fund, is an investment vehicle that pools investor money together and invests in various pools of investments. The pooled investment funds will then make individual investments in different projects based on the fund’s strategy.
Types of funds of funds
In a Long Hedge Fund, the managers invest with the goal to provide high returns for the investors and take advantage of opportunities arising by investing in different markets, sectors or industries at different times in different ways. A typical long hedge can be very long term for instance 40 years invested over 10–15 years .
In a Short Hedge Fund, the manager aims to limit the downside risk with the goal of providing high returns for the investors. A typical short hedge can be very short term for instance 1-3 months invested over 1 week .
Another common type of fund of funds is one which invests in fixed income instruments such as bonds. The Fixed Income Funds could be considered as long Hedge Funds because they invest in different markets, sectors or industries at different times over a period of time. They are usually long term, with 5 to 10 years investment horizon and can invest all maturity segments up to 100 years plus.
The Fund of Funds typically invest in different types of bonds (fixed income). The main objective is to provide high returns by taking advantage of opportunities arising in different markets, sectors or industries at different times. They are usually long term (5 to 15 years investment horizon) and could invest all maturity segments up to 100 years plus.
A common reason for investing in a fund of funds is to diversify the portfolio by spreading the money over a wide range of investments. This diversification can be achieved by investing in only one fund, or several funds together. This type of fund is often referred to as a “fund of funds” and a “fund of funds” typically invests in one or more funds, but some may invest all their assets in one fund.
Are FoFs right for you?
A fund of funds (FoF) is a type of investment portfolio that consists of a group of various mutual funds. These types of investments are specifically attractive to those investors who wish to gain more diverse holdings, relative to those obtained from investing in individual stocks and bonds. However, the downside is that FoF investments require more time and effort on the part of the investor as compared with informal buying and selling. In some circumstances, the investment holdings may possess somewhat high fees – although this varies – which also affects performance for investors who invest in these products.
