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A "fund of funds" is an investment fund that uses an investment strategy of holding a portfolio of other investment funds rather than investing directly in shares,
bonds or other securities. This type of investing is often referred to as multi-manager investment.
There are different types of 'fund of funds', each investing in a different type of collective investment scheme (typically one type per Fund of Funds), eg. 'mutual fund' Fund of Funds,
hedge fund Fund
of funds, private equity Fund of Funds or investment trust Fund of Funds .
Some investment managers offering retail Fund of Funds may limit the fund selection to only include the range of funds they manage; this type of arrangement is called a 'fettered' fund of funds. Most Fund of Funds offerings include funds from various investment managers and are called 'unfettered' fund of funds.
There is a special type of investment fund called a fund of funds,
which invests only in other investment funds (e.g., hedge funds) rather than
trading assets directly. Because some U.S. funds of funds may be specially
registered with the SEC, they can accept investments from individuals who are
not accredited investors or qualified purchasers, and often have lower
investment minimums (sometimes as low as $25,000).
Funds of funds carry an additional layer of fees, typically a 1% management fee
and, optionally, a 10% incentive (performance) fee, in return for their due
diligence on a selection of hedge fund managers. Besides lower mininum
investment hurdles and diversification, some funds of funds also add value (or
"justify" the extra layer of performance fee) by dynamic allocation to different
hedge funds strategies, such as Long/Short Equities, Event Driven, Distressed
Debt, Convertible Arbitrage, Statistical Arbitrage, Macro and Multi-Strategies.
Fund of Hedge Fund management companies either invest directly into the hedge
funds by buying shares or offer investors access to managed accounts which
mirror the performance of the hedge fund. Managed or segregated accounts have
grown in popularity because they provide investors with daily risk reporting and
help protect the assets if the hedge fund goes into liquidation.
Fund of Funds Pros & Cons
These funds are designed to achieve even greater diversification than traditional collective investment schemes. On the downside, management fees on fund of funds are typically higher than those on tradition investment funds because they include part of the management fees charged by the underlying funds.
Since a fund of funds buys many different funds which themselves invest in many different stocks, it is possible for the fund of funds to own the same stock through several different funds and it can be difficult to keep track of the overall holdings.
Funds of funds are often used when investing in
hedge funds, as they typically have a high minimum investment level compared to traditional investment funds which precludes many from investing directly. In addition hedge fund investing is more complicated and higher risk than traditional collective investments; this lack of accessibility favours a Fund of Funds with a professional manager and built in spread of risk.
Pension funds and other institutions often invest in funds of funds for part or all of their "alternative asset" programs, i.e. investments other than traditional stock and bond holdings.
Some Funds of Funds Examples
Alternative Growth Fund