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A Primer on Fund of Funds
A Fund of Funds pools investor money to buy multiple individual funds in one portfolio and can provide significant diversification benefits to the investor. The underlying funds can be mutual funds, hedge funds, venture capital funds, private equity funds, or many others. A fund of funds may also be known by the term multi-manager investment or collective investment scheme. A fund of funds allows an investor to hold a single portfolio containing a wide variety of funds. In the past, investors would need to invest in several different mutual funds (or hedge funds, venture capital funds, or private equity funds) to achieve true diversification. However, the advent of the fund of funds allows investors to enjoy the benefits of investing in several different funds through one fund.
Overall Strategy of a Fund of Funds
With a fund of funds, investors no longer have to take on the cumbersome task of tracking, reviewing, and evaluating each individual fund in their portfolio. Instead, the portfolio manager of the fund of funds performs these tasks in accordance with the fund of funds’ overall strategy. The portfolio manager will screen each fund for performance, strategy, risks, correlation with other funds, management, market valuations, and outlook, among many other factors, as well as performance the necessary due diligence to make sure the fund is not fraudulent. The portfolio manager of the fund of funds may choose underlying funds with similar investing strategies to gain more exposure to those strategies, choose less-correlated strategies for greater diversification, or for some other overall strategy.
Another benefit to investing in a fund of funds is that investors may be able to access funds not previously available to the individual investor. A collective investment scheme can pool together investors’ capital to invest in funds with very high account minimums or funds that are closed off to new individual investors. This way, private investors are able to access the funds, strategies, and returns they were not previously able to. Additionally, a fund of funds allows investors to invest in a greater number of securities than if investors were investing alone. Statistics show that diversifying a portfolio of stocks can reduce volatility, which can lead to a better return without added risk. However, investors must always remember that no investment is without risk. A fund of funds can also offer investors active management that is based on experience, knowledge, and thorough market research and analysis. For example, a portfolio manager may be able to access market research and technical analysis that is not available to individual investors or is too costly to access. Portfolio managers also have expertise and experience that novice investors may not have.
Investors choosing between different funds of funds should take several factors into consideration. For example, investors should be aware of all management fees associated with a fund of funds. Investors should also evaluate the expertise of the portfolio managers and review the performance record of the fund of funds. As with any investment, whether you participate in collective investment schemes or purchase funds individually, it is important to do your due diligence and speak to a financial advisor first about your decisions.
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