A “Fund of Funds” or “FOF” is an investment structure that invests in a portfolio of other investment funds rather than holding direct investments in stocks, bonds and other assets. The idea is that as an investor you can make a single investment in a Fund of Fund, while receiving the diversification benefits associated with investing in several different investment funds. Below is a chart which shows the typical structure of a Fund of Funds.
“Simplified” Fund of Funds Structure
OK, so the chart is not that simple, in fact it can be down right confusing. But there are a few “take-aways” that I want readers to understand about Fund of Funds:
- An investment in a Fund of Funds is not a direct investment in stocks, bonds and other assets. As you can see in the chart, investors are 2 levels away from the actual investment assets. You own shares, which own shares, which reference actual assets.
- This means that there are two sets of investment managers, the Fund of Funds manager and the investment fund managers. Here is the important part: BOTH MANAGERS TAKE FEES. So, when you invest in a Fund of Funds, the Fund of Funds investment manager (not shown in the chart) takes a fee, usually a percentage of assets (about .10% to 1% of assets) and then the investment fund manager (not shown) that manages the investment fund(s) takes its fee for managing the stocks, bonds, etc… (usually another .20% to 2% of assets).
It’s your job as an investor to do your homework and make sure these managers are not “double-dipping” on fees. In other words, if the marketing paperwork states fees of .50%, you need to make sure that covers the investment managers at BOTH levels.
-The Fund of Funds manager is supposed to be an expert at picking high quality managers. Unless you are investing in an index Fund of Funds, you probably want to make sure the Fund of Fund manager actually has a rational approach for identifying talented investment managers with a track record to manage the underlying investment funds.
So, what’s a “Round-up of Round-ups”?
Well, a “Round-up” is a compilation of blog posts by bloggers. So, I will give you one guess what a “Round-up of Round-ups” “RUORU” is?
You guess it: An RUORU is a compilation of blog posts by bloggers that are comprised of blog posts by other bloggers.
Confused? Don’t be, just check out my favorite Personal Finance Rounds-Ups listed below and enjoy:
Great Attributes Round Up RoshawnWatson.com’s Uncommon Round Up
Best of Weekend Reading: Yakezie Challenge Edition YoungAdultFinances.com
More Slacker Team Link Love – SoOverDebt.com
Weekly Roundup 12-12-11: Best of the Best! MoneyIsTheRoot.com
Albert Pujols, Chris Paul Thank You Roundup BuckInspire.com
Friday Night Links: Boomer or Late Bloomer? KrantCents.com
Link-Love #14 NickelByNickel.com
Links From A Slacker DebtFreeByThirty.net
Related posts:
Thanks for including my round up!
Interesting idea… but that’s a lot of links to drill through!
Yep, it is a lot of links, but the good news is that you can get to them all from one place: This site…
Hmm. Leaving the Round-up of Round-ups aside, the Fund of Funds is interesting. As I understand it, the difference between FoF and a mutual is that the former can contain all sorts of funds which work in different markets – FX, bonds, stock etc. whereas a mutual will concentrate on only one market. Now these individual funds will probably have entirely different growth characteristics so while the expected values may not differ by much, the range when you may be persuaded to buy or sell will be. Where there is large volatility, there is also a lot more opportunity to buy low, sell high.
I suppose as things grow or shrink by percentages, you could work in logarithms and invoke the Central Limit Theorem…. Skiddles off to look for some books on econometrics and financial mathematics….:-)
Not a fan of the RUORUs? Well, it is a lot of clicking and reading, but it certainly centralizes many good stories in one spot.
FoFs can take various forms, they can be as simple as a Vanguard Retirement Mutual Fund that invests in only 3 index mutual funds or they can be quite complex. For example, the FoF could invest in a combination of mutual fund, ETFs, CEFs, hedge funds, separately managed accounts or other vehicles with complex strategies. The idea is that a FoF manager builds a portfolio of funds based on the various focus exposures (as you mentioned, equities, bonds, US/International Debt, short strategies, etc) by trying to pick the best manager to run an actively-managed portfolio or to mimic a particular index. If it is actively-managed portfolio you are looking for talent and outperformance while for indexing you want to find a fund with the low tracking error and the lowest possible fees.
Now, many of the more complex FOFs are only available to accredited investors because they invest in hedge funds or other complex structures. But I have certainly see FOFs that focus on unique strategies that are available to retail investors. For example, GAM recently launched a retail fund of hedge fund product. I believe there are also ETF and Closed-end Fund (CEF) FoF products as well.
You had me thoroughly confused at a few points there, so how is a fund of fund different from a mututal fund? One more level up, did I understand that right? (sorry, n00b)
Thank you for the linklove
Andrea, I hate to hear that I confused you and that my overview was not clear
The main difference between a fund of funds “FOF” and a mutual fund is their method of investment. Mutual Funds buy securities (stocks, bonds, etc…) using cash provided by investors like you and me. FOFs take investor cash and buy shares of multiple different mutual funds (or other types of funds). That’s really the key difference. So, as you mentioned, as an investor in an FOF you are another level away from the actual stocks and bonds, etc…
The main concerns you have to think about with FOFs are increased fees and liquidity. The reason liquidity is an issue is that you are “two levels away”. This is normally not an issue for retail FOF products, but if you start getting into complex strategies and hedge funds you have to start thinking about the mechanics. Let’s say you need the cash you invested right now and you call the FOF Manager and say “give me my money”. The reality is that the FOF manager does not have your money. He has to call the underlying fund manager to get it and that might take some time. Again, this is issue is more relevant for complex FOF products.
Please let me know if you want to discuss further: info @ NetWorthProtect . com
Love it
BSimple who was a part of the challenge used to do this. Sadly, she is no longer blogging on that site, but I’m glad you have (unknowingly?) picked up the torch. Also, thank you for listing my “uncommon” round up 
Love that too. You rock!
Roshawm, I did not even know BSimple existed, so I guess it’s just that great minds think alike. Glad you like the RUORU!
Heard of a ‘Fund of Funds’, Well This is a ‘Round-Up of Round-Ups’ http://t.co/hOopTWqU @NetWorthProtect
I invested in a fund of funds a couple years back and really regret it now. It had a couple of big names in it like Paulson, but all I see is that it lags my other investments and with huge costs to boot. Hedge funds do have a place in asset allocation, but a fund of funds is pointless. Find a good hedge fund that will protect you wealth in bad times – like the Millennium Fund – and also allow you capture as much as possible of the upside, and you will come out much further ahead.
Right, one of the issues with FOHFs (Fund of Hedge Funds) is the huge fees: 1% / 10% on top of the underlying fund fees of 2% / 20%. These fees really kill your returns if FOHF performance does not come through on its “absolute return” mandate. For those that do not know, 1% / 10% and 2% / 20% are typical fee structures in the hedge fund world. What it means is that the investment manager will charge a 1% management fee and a 10% performance fee (in the case of FOHFs) and 2% management fee and 20% performance fee for underlying hedge funds. The performance fee is a big fee, but the manager only gets it if the fund performs well. For example, if a fund makes a 10% return in a year, the FOHF investment manager will take 10% and the Hedge Fund manager will take 20% of that 10% return. So, investing through a FOHF means that on a 10% return, the investor first has to pay the hedge fund manager his 20%, reducing the return to 8% and THEN has to pay the FOHF manager his 10% thus reducing the investor’s return to 7.2%. Like I said, very pricy!
Alot of folks are re-evaulating FOHFs these days and are opting to invest with a few solid, brand name hedge fund managers.
What a cool idea! Thanks for the mention!
Glad you like the idea, I will stick with it!
Nice little tutorial. It certainly points out h=the importance of needing to do the homework yourself and understand the investment that you are entering into. nice list of roundups too
Thanks! I agree that investors really need to read the fine print and understand what they are buying. Just trusting someone else completely is not wise… Also, I think people really do not understand the risks embedded in ETFs, especially leveraged ETFs. There is serious counterparty risk in there that people do not realize. I get comfortable by looking through to the swap counterparties and looking at the diversification of these counterparties. But I bet most people don’t even realize they are facing banks and other financial institutionals that might not be able to pay if they end up like MF Global.
Thanks for the links, I really appreciate it.