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A "fund of funds" (FoF) is an investment fund that uses an investment strategy of holding a portfolio of other investment funds rather than investing directly in shares, bonds or other securities. This type of investing is often referred to as multi-manager investment.

There are different types of 'fund of funds', each investing in a different type of collective investment scheme (typically one type per FoF), eg. 'mutual fund' FoF, hedge fund FoF, private equity FoF or investment trust FoF.

Features

Investing in a collective investment scheme will increase diversity compared to a small investor holding a range of securities directly. Investing in a fund of funds arrangement will achieve even greater diversification.

An investment manager may actively manage your investment with a view to selecting the best securities. A FoF manager will try to select the best performing funds to invest in based upon the managers past performance and other factors. If the FoF manager is skillful, this additional level of selection can provide greater stability and take on some of the risk relating to the decisions of a single manager. As in all other areas of investing, there are no guarantees for regular returns.

Considerations

Management fees for funds of funds are typically higher than those on traditional investment funds because they include part of the management fees charged by the underlying funds.

Since a fund of funds buys many different funds which themselves invest in many different securities, it is possible for the fund of funds to own the same stock through several different funds and it can be difficult to keep track of the overall holdings.

Funds of funds are often used when investing in hedge funds and private equity funds, as they typically have a high minimum investment level compared to traditional investment funds which precludes many from investing directly. In addition hedge fund and private equity investing is more complicated and higher risk than traditional collective investments. The lack of accessibility favors a FoF with a professional manager and built in spread of risk.

Pension funds and other institutions often invest in funds of hedge funds for part or all of their "alternative asset" programs, i.e. investments other than traditional stock and bond holdings.

Private equity fund of funds

According to Preqin (formerly known as Private Equity Intelligence), in 2006 funds investing in other private equity funds (i.e., fund of funds, including secondary funds) amounted to 14% of all committed capital in the private equity market. The following ranking of private equity fund of fund investment managers is based on information published by Private Equity Intelligence:

Rank Name of the firm Currently Committed to PE (billions of USD) Headquarters 1 AlpInvest Partners $42.3 Amsterdam 2 AXA Private Equity $34.9 Paris 3 AIG Investments $24.6 New York 4 Goldman Sachs Private Equity Group $24.0 New York 5 Pantheon Ventures $22.6 London 6 Pathway Capital Management $20.6 Irvine, California 7 Capital Dynamics $20.0 Zug, Switzerland 8 Partners Group $19.6 Baar-Zug, Switzerland 9 Lehman Brothers $19.0 New York 10 HarbourVest Partners $17.8 Boston, Massachusetts 11 PCG Asset Management $15.0 San Diego, California 12 Credit Suisse Customized Fund Investment Group $14.0 New York 13 Adams Street Partners $12.0 Chicago, Illinois 14 Horizon21 Alternative Investments $11.5 Pfaeffikon, Switzerland 15 LGT Capital Partners $10.9 Pfaeffikon, Switzerland 16 Standard Life Investments $9.3 London 17 Allianz Private Equity Partners $7.9 Munich 18 Portfolio Advisors $7.5 Darien, Connecticut 19 Commonfund Capital $7.5 Wilton, Connecticut 20 Horsley Bridge Partners $7.1 San Francisco, California 21 SVG Capital $7.0 London 22 European Investment Fund $6.8 Luxembourg 23 Macquarie Funds Management Group $6.1 Sydney 24 Abbott Capital Management $6.0 New York 25 Natixis Private Equity $5.7 Paris

Source: Preqin (formerly known as Private Equity Intelligence)¹

Fund of hedge funds

A fund of hedge funds is a fund of funds that invests in a portfolio of different hedge funds to provide broad exposure to the hedge fund industry and to diversify the risks associated with a single investment fund. Funds of hedge funds select hedge fund managers and construct portfolios based upon those selections. The fund of hedge funds is responsible for hiring and firing the managers in the fund. Some funds of hedge funds might have only one hedge fund in it, thus lets ordinary investors into a highly-acclaimed fund, or many hedge funds.

Funds of hedge funds generally charge a fee for their services, always in addition to the hedge fund's management and performance fees, which can be 1.5% and 15-30%, respectively. Fees can reduce an investor's profits and potentially reduce the total return below what could be achieved through a less expensive mutual fund or ETF.

While funds of funds conceptually can provide extremely useful services for many hedge fund investors, they have been criticised for the significant incremental costs they impose. (The underlying hedge funds usually charge fees of between 1 and 2% of assets managed and incentive fees of 15–25% of profits generated. The funds of funds typically add additional fees of 1% and 10%, respectively). Moreover, fund-of-funds behavior has often exhibited crowd-following tendencies, suggesting the managers of these funds prefer to match indices rather than seek opportunities.

The industry has recently been criticized by some hedge fund managers for a reputation of holding a short-term view. Some hedge funds have even started turning away fund of hedge funds money. “It is really beginning to irritate those funds of hedge funds that approach their investments sensibly,” says one fund of hedge funds manager.²

Other examples

• Vanguard STAR is a popular U.S. mutual fund that invests in other Vanguard mutual funds. Assets include U.S. and non-US stock funds, long and short-term bond funds, a GNMA fund, and a money market fund. The fund itself does not have any fee.

• A similar one is "Vanguard Life Strategy Moderate Growth", which invests in four other Vanguard funds, and again has no fee itself.

See also

• Collective investment schemes
• Investment management
• Manager of managers fund
• Bernard Cornfield, operator of perhaps the first "Fund of Funds" from 1962 until its collapse in 1970. [1].

References

v • d • e Topics on private equity and venture capital Basic investment types Buyout • Venture • Growth • Mezzanine • Secondaries • Equity co-investment History History of private equity and venture capital • Early history of private equity • Private equity in the 1980s • Private equity in the 1990s • Private equity in the 21st century Terms and concepts Buyout Financial sponsor • Management buyout • Divisional buyout Venture Seed money • Startup company • Angel investor • Venture capital financing • Pre-money valuation • Post-money valuation • Venture round • Venture debt Structure Private equity firms and funds • Limited partnership • Limited liability company • Carried interest • Publicly traded private equity • Private Investment in Public Equity (PIPE) Investors Institutional investors • Pension funds • Insurance companies • Endowments • Fund of funds • High net worth individuals • Sovereign wealth funds Related financial terms Initial Public Offering (IPO) • Mergers and acquisitions • Leverage • High-yield debt • Capital structure Private equity and venture capital investors • Private equity firms • Venture capital firms • Portfolio companies