Building a Successful Fund of Funds Portfolio

A fund of funds (FOF) is an investment vehicle that pools money to invest in other funds, providing diversification and risk management for investors. It’s a type of multi-manager investment, where a single fund invests in multiple underlying funds.

Why invest in a fund of funds?

Funds of funds offer several advantages to more individual investment vehicles:

• Diversification: by investing in multiple funds, funds of funds increase potential returns by spreading investments across entire sectors or categories

• Risk management: another benefit of diversification, raising the number of different assets in your portfolio lowers inherent risk

• Convenience: a fund of funds allows you to access numerous funds from one central portal

• Professional management: many funds of funds are professionally managed, requiring less monitoring and upkeep from you

How a fund of funds works

A fund of funds works as an investment vehicle holding numerous individual funds, like a folder file containing multiple other files. The number of funds within a fund of funds can range from a handful to hundreds, and typically they are grouped by a specific investment strategy.

Funds of funds can contain other mutual funds, exchange traded funds, hedge funds, and various other different funds. FOFs can either be fettered or unfettered. Fettered funds of funds can only invest in individual funds of the same management company, essentially creating packaged deals for their in-house funds. Unfettered funds of funds can invest in different funds from any investment company, but these often come with more fees.

Funds of funds are professionally managed. Be aware that most fund of funds charge double expenses: a fee for management, and another expense for the underlying funds. The fees associated depend on the type of fund of funds you invest in.

Types of Funds of Funds

Each fund of funds differs depending on the types of funds it includes. Some can consist of mutual funds, some index funds, and others private equity funds. They can also have specific targets, like a fettered fund which invests solely in funds held by the same management company, as opposed to unfettered funds.

Mutual Funds of Funds

A mutual fund of funds invests in a diversified portfolio of mutual funds, offering broad exposure to various asset classes. A mutual fund of funds is a convenient option for investors seeking professional management and diversification.

Hedge Funds of Funds

A hedge fund of funds invests in a diversified portfolio of hedge funds, providing access to alternative investments and strategies. It’s a way for investors to tap into the expertise of multiple hedge fund managers without meeting the securities and exchange commission (SEC) regulations limiting hedge fund participation to accredited investors with high incomes or net worths.

Hedge funds of funds also mitigate some of the managerial and strategy risks notable in singular hedge funds, but they're still riskier than mutual funds and typically charge higher fees.

Private Equity Funds of Funds

A Private equity fund of funds provides access to a variety of PE funds in a single investment vehicle. Private equity fund of funds will often target a specific strategy or sector, including numerous PE funds that fit the theme such as buyouts, growth portfolios, infrastructure, or fintech.

Target Date Funds of Funds

Target date funds of funds are used primarily for retirement plans, so the funds included shift over time from a majority of stock-based funds to bond and fixed-income-based funds as the fund of fund nears its target date.

Target date fund of funds are useful for investors who are looking to shift their risk allocation over time without monitoring and adjusting their mix of investments themselves.

How to select experienced fund managers

All funds of funds are professionally managed, so When choosing fund of funds investments, look for funds managed by financial experts with a proven track record and expertise in their respective asset classes. Experience managing funds of funds is also relevant, since these assets are more complicated than other investment funds. Consider factors such as investment style, risk tolerance, and fees when selecting fund managers.

Understand the fee structure of the fund of funds, including acquired fund fees and management fees. Consider the impact of fees on investment returns and choose a fund with a competitive fee structure

Build a mutual fund of funds or hedge fund of funds

Hedge funds and large, institutional investors looking to build their own fund of funds might be better off working with a prime brokerage like StoneX to create and manage their own portfolio of funds.

Construct a diversified portfolio by investing in multiple funds across various asset and strategies. Regularly review and rebalance the portfolio to ensure it remains aligned with investment objectives. Stay up-to-date with market trends and adjust the portfolio to maintain an optimal asset allocation.

Fund of Funds FAQs

What is a fund of funds for startups?

A fund of funds for startups is an investment strategy that pools capital from various investors to invest in a diversified portfolio of venture capital or private equity funds. These underlying funds then invest in early-stage startups and emerging companies. This approach allows investors to gain exposure to a broad range of startups and leverage the expertise of multiple fund managers, reducing the risk associated with investing in individual startups.

What is a fund of funds scheme?

A fund of funds scheme is an investment strategy where a fund invests in a collection of other funds rather than directly in stocks, bonds, or other securities. This method aims to achieve broad diversification and professional fund management. By spreading investments across various underlying funds, investors benefit from the expertise of multiple fund managers and reduce the risk inherent in single-manager funds.

Is fund of funds liquid?

The liquidity of a fund of funds can vary significantly. Some fund of funds offers regular redemption opportunities, making them relatively liquid. However, many fund of funds, particularly those investing in private equity or venture capital, have longer lock-up periods and limited liquidity. This is due to the nature of the underlying investments, which are often illiquid and require longer time horizons to realize returns.