Fund of Funds (FOF) Definition

What Is a Fund Of Funds (FOF)?

A fund of funds (FOF)—also referred to as a multi-manager funding—is a pooled funding fund that invests in different varieties of funds. In different phrases, its portfolio accommodates completely different underlying portfolios of different funds. These holdings substitute any investing instantly in bonds, shares, and different varieties of securities.

FOFs often spend money on different mutual funds or hedge funds. They’re sometimes labeled as “fettered,” or solely in a position to spend money on funds managed by the FOF’s managing firm, or “unfettered,” or in a position to spend money on funds throughout the market.

How a Fund Of Funds Works

The fund of funds (FOF) technique goals to realize broad diversification and applicable asset allocation with investments in a wide range of fund classes which are all wrapped into one portfolio.

There are completely different sorts of FOFs, with every sort appearing on a distinct funding scheme. A FOF could also be structured as a mutual fund, a hedge fund, a personal fairness fund, or an funding belief. The FOF could also be fettered, which means it solely invests in portfolios managed by one funding firm. Alternatively, the FOF might be unfettered, letting it invests in exterior funds managed by different managers from different firms.

Fund of Funds Benefits

Usually, FOFs appeal to small buyers who need to get higher publicity with fewer dangers in comparison with instantly investing in securities—and even in particular person funds. Investing in a FOF offers the investor skilled wealth administration companies and experience.

Investing in a FOF additionally permits buyers with restricted capital to faucet into diversified portfolios with completely different underlying belongings. Many of those could be out-of-reach for the common retail investor. For instance, hedge funds sometimes require six-figure minimal investments or require buyers to have a minimal internet price—or each.

Most FOFs require a proper due-diligence process for his or her fund managers—each their very own and people managing the underlying funds. Making use of managers’ backgrounds are checked, which ensures the portfolio handler’s background and credentials within the securities trade.

Fund of Funds Disadvantages

Although FOFs present diversification and fewer publicity to market volatility, these returns could also be lessened by funding charges which are sometimes increased than conventional funding funds. Larger charges come from the compounding of charges on prime of charges.

Like most mutual funds, a FOF carries an annual working expense—referred to as the expense ratio—in addition to administration charges and working prices. Nevertheless, FOFs buyers are basically paying double—as a result of the underlying funds within the FOF all have their annual prices and charges, too.

Previously, funds of funds’ prospectuses did not at all times embrace the charges of the underlying funds. As of January 2007, the SEC started requiring that these charges be disclosed in a line referred to as Acquired Fund Charges and Bills (AFFE).

A fund of funds may cost annual administration charges of 0.5% to 1% to spend money on funds that cost one other 1% annual administration charge. So, the FOF investor in sum is paying as much as 2%. Small marvel that, after allocating the cash invested to charges and different payable taxes, the returns of fund of funds investments might usually be decrease in comparison with the earnings that single-manager funds can present—even when the funds carry out very nicely.

Selecting good fund managers and funds might be tough, too—particularly if the FOF is fettered. The FOF might find yourself proudly owning the identical inventory or different safety by way of a number of completely different funds, thus lowering the precise diversification.

Actual World Instance for Fund of Funds

Since they’re so various, funds of funds might be exhausting to trace as a bunch and to check. Nevertheless, an index does exist. The Barclay Fund of Funds Index, sponsored by Barclay-Hedge, a supplier of knowledge on various investments, is a measure of the common return of all FOFs that report into the corporate database. By Q1 2022, for example, 156 funds of funds had yielded a median return of 0.33% year-to-date. The S&P 500 throughout the identical interval misplaced greater than 7.5%.