Fund of Funds is an investment strategy in which a fund invests in other types of funds. This type of investment is called multi-manager investment. It invests in a portfolio that has different underlying assets instead of investing directly in stocks, bonds, and other securities.
This kind of strategy aims to achieve a broad diversification and appropriate asset allocation by investing in a variety of fund categories. These funds were brought into the limelight by a $ 1 million bet between Warren Buffet and hedge fund manager Protege Partners.
Buffet bet that S&P 500 Index fund would beat the performance of 5 funds of funds picked by Protege Partners over a period of 10 years, after fees. So far it looks like Buffet might be winning the deal.
The Fund of Funds attracts small investors who want to get exposure to few risks compared to investing directly in securities. The most common example of Fund of Funds is target date mutual fund. For example, TATA’s target date mutual funds pool of investors capital and invest in other TATA’s funds. These kinds of funds are common in hedge funds. These have a high minimum investment which exceeds $ 1 million or more.
Hence, investors who cannot pull enough money to invest in such high amounts invest through a fund of funds.
Features of Fund of Funds
Below are some of the significant features of the fund of funds.
- They offer a diversification of investment.
- It reduces the volatility of funds and provides average return on the investment.
- It is a huge collective investment scheme which provides investors with many options to invest in.
- It is easy to keep track of funds.
- Consulting a fund manager is mandatory as it requires some professional knowledge about the stock market.
Advantages of Fund of Funds
Investing in Fund of Funds allows an investor to test the investing in professionally managed funds before going for individual funding. Most of the Fund of Funds require a formal process before investing.
- It also allows the investor to invest with a limited capital which would otherwise not be accessible to him traditionally.
- The risk of investment is lower due to diversified investment in funds. Hence, the now- performing stock will not affect your entire portfolio.
- The investment is made through various hedge funds which increase the potential for good returns.
- A professional manager works to capture the best performing funds which increase the potential for higher returns.
Disadvantage of Fund of Funds
Despite having some eye-catching advantage the Fund of Funds has its own set of disadvantages.
- Fund of Funds investment comes with high investment fees. Over a period of time, the burden of additional fees makes it difficult to provide good returns.
- These funds come with limited redemption facility. This means that the investor is unlikely to redeem his investment in liquid cash whenever they wish.
- Fund of Funds has a complex form of tax structure. They have to pay tax on the capital gain even if recovered in cash.
- It is difficult to pick the best stocks just like to pick the best fund manager.
An investment with Fund of Funds is a good way to enter the investing world if you are an amateur investor. Over a couple of years, more people are seen investing in a fund of funds. This has led to a faster growth of this scheme of investment. The rapid changes in the economy have provided a lot of attention as it provides security. The fund of funds is also known as “fettered” which means it invests only in funds managed by the same investment company.