A fund of funds is a type of investment opportunity like a mutual fund or hedge fund that concentrates its investments specifically on other funds. Instead of securities like stocks or bonds, this type of fund, which collects investments from multiple investors who all share in the profits, will only take on other funds in its portfolio. In this way, a fund of funds provides a tremendous amount of diversity for an investor at a relatively small cost. The investor must be aware that part of the cost for investing in these collective investments is for management of not just the fund itself but for the management of all of the individual underlying funds within it.
Diversity within a portfolio is sought by many investors, as it allows them to spread money to many different locations and mitigate risk. If a portfolio is well diversified, one or two bad investment vehicles can be overcome. Mutual funds are popular investments because they achieve this goal of diversification. A fund of funds goes even further by concentrating solely on mutual funds themselves, thereby spreading out the investment capital to an extremely wide degree.
Like a normal mutual fund, a fund of funds is professionally managed by someone who will invest the money within it in an attempt to achieve the greatest possible gain. The professional management is a luxury that many investors seek out, as these professionals know the market inside and out. In addition, the investor in these collective investments can choose the strategy that best suits his or her investment needs. Some of these funds will focus on funds that have a unifying strategy, while others will go for a more across-the-board approach with the funds they include.
Cost effectiveness is another benefit to a typical fund of funds. Many mutual funds are very prohibitive in their initial costs, but a fund that juggles several mutual funds would offer the investment expertise of all of the funds within it at the price of just the collective investment itself. It allows the investor to get more mileage out of the capital spent.
The fact that a fund of funds is also known as a multi-manager fund is a hint at one of its main drawbacks. In any mutual fund, part of the fee required for investment is allocated to the management of the fund. A fund that gathers several funds would not only include the management fee of the overarching fund, but it would also essentially include the management fees of all the underlying funds within the larger investment. Investors should be aware of how much of their investment is tied up in these fees before proceeding.