What are Fund of Funds (FoF)
Investing always carries risk. However, it is possible for investors to mitigate risk by diversifying. Fund of funds are one of the most popular diversification options — and they can be an excellent solution for a comfortable retirement.
Fund of Funds Explained
An FOF invests in other funds instead of directly investing in securities, stocks, bonds and other options. The main investment strategy of an FOF is to achieve maximum diversification.
These FOFs can give investors access to a wide array of asset classes such as private equity and real estate. They are also made up of professionally managed portfolios that have varied risk management styles.
What Are the Different Types of Fund of Funds?
Here are some of the most popular fund of funds.
Fund of Funds That Take a Multi-Asset Strategy
A common FOF is a multi-asset fund. Investments by these funds will generally consist of several funds spread across different asset classes. This includes mutual funds investing in stocks and other funds investing in real estate, bonds and gold or other precious metals.
Fund of Funds for International Exposure
International FOFs invest in other funds all over the world, providing investors with global exposure managed by regional experts. Fund managers often have unique insights into companies within the portfolio that can result in more effective fund management.
ETF Fund of Funds
Exchange-traded fund FOFs invest in ETFs. An ETF will track a particular asset class, geographic market, industry, sector or index such as the S&P 500 or the FTSE. One such example is gold FOFs which invest in gold ETFs with 99.5% purity.
Target-Date Fund of Funds
Target-date FOFs are another popular FOF option. These funds are ideal for those that are preparing for retirement. This is because the investment strategy is adjusted based on an investor’s retirement timeline.
For example, a target-date fund with a 2050 timeline would involve more risk now, and it would shift to a more risk-averse investing stance as the target date nears. Once the target date is reached, these FOFs will generally either maintain a low-risk strategy or alter their purpose for income generation.
What Are the Benefits of Fund of Funds?
FOFs offer maximum diversification for investors by providing exposure to a broad range of assets. Ultimately, this will balance both good and bad investments for investors, decreasing overall volatility.
FOFs also let investors take a hands-off approach, as all funds are managed by professional investment teams. By outsourcing these processes, investors can save themselves the time and energy required to manage their own portfolio of investments.
The added bonus here comes with the expertise of particular industries. An investor may know they want exposure to a certain industry but they may not be sure what to invest in — an asset manager can solve this issue.
What Are the Disadvantages of Fund of Funds?
An FOF can have a management fee, and the funds it invests in could have more fees on top of that. This leads to a high expense ratio for investors for a fund that has zero guarantees of earning a strong return.
Other negative knock-on effects of FOFs include over-diversification and a lack of transparency. It can be difficult to keep track of everything an FOF is invested in when capital is spread so widely. Mass diversification can also lead to returns that will sometimes lag the market.
Are Fund of Funds Worth It?
FOFs can be worth it depending on an individual’s investing goals. If wealth preservation and minimum volatility are the primary concerns, FOFs can be a great option. The downsides include layered fees, which will eat into any profits earned, and the potential of missing opportunities that may offer higher rewards.
A more concentrated portfolio can outperform FOFs. Investors should bear in mind, though, that this also comes with more risk.
What Are the Top Fund of Funds?
One of the top-performing FOFs is the ICICI Pru Asset Allocator Fund. The fund has had a compound annual growth rate of 12.9% over the past seven years. It is an Indian-based fund that invests in mutual funds and insurance funds targeting large-cap value stocks.
Another FOF that has historically performed well against its benchmark is the Vanguard Diversified Equity Fund. It invests in its own individual funds to spread risk across large-cap value, growth and dividends. Here are the total returns for 2017 to 2021:
2017: +21.69%
2018: +28.98%
2019: +31.45%
2020: -5.39%
2021: +22.7%
Final Take
FOFs offer pathways for investing to investors with varying risk tolerances. Although they offer instant diversification, one of the core drawbacks is that the aggregate fees will tend to be higher than DIY investing. That being said, this cost may be worth it for people who lack the time and expertise necessary to follow the investment market.
Information is accurate as of July 27, 2022.
This article originally appeared on GOBankingRates.com: What are Fund of Funds (FoF)
