What is a Fund of Funds?

Financial experts are extremely creative, coming up with new and more complicated investment options every year.

The fund of funds is a prime example of the creativity of the experts in the financial market. It is essentially a fund that invests its portfolio in other types of funds to diversify its investments. This gives investors an even more diversified portfolio of multiple assets managed by different managers.

In theory, this may sound like a great idea, but there are also downsides to this sort of investing. Before putting our money down for one of these investments, it is vital that we know the key advantages and disadvantages of such a fund.

Pros of investing in a fund of funds

  • Diversification

Fund of funds provides diversification across multiple asset classes and geographical locations. This invariably leads to lower volatility and returns are less likely to be affected by a single major event.

  • Professional management

Investors can rest easy that someone who has shared interest in the fund’s performance and is highly qualified to choose the right investments for the fund manages their money. Having said that, not all fund managers perform equally and choosing the right fund with the best man for the job is essential in ensuring your investments can achieve consistently strong long-term returns.

  • Access to funds without the need to scrutinise individual funds

If you want to invest in hedge funds but do not know which ones to choose, then a fund of funds provides the perfect platform to achieve that.

Cons of investing in a fund of funds

  • Lower returns

Unfortunately, funds of funds are usually an aggregate of the performance of many funds. Therefore, performance is generally muted due to diversification and inability to capitalise on a single over-performing asset class.

  • Additional fees

On top of the usual management fees, fund of funds has to pay additional fees to the funds that they invest in, further muting investment returns

  • Investors have no say in the investments

Typically, once an investor decides to invest in a fund of funds, he is subject to the decisions made by the fund manager.

The Foolish bottom line

Fund of funds can provide diversification and significantly less risk than individual hedge funds. However, they do incur their own set of disadvantages and costs to investors. Investors who wish to invest in this investment option should consider if the risk-reward profile matches their financial goals before making a decision.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.