Pooling money to invest in a fund is a common strategy that allows investors to diversify their portfolios while mitigating risks and hedging against inflation. Investors, financial managers and finance advisors have to make this strategy even better using funds of funds.
What are funds of funds
A fund of funds (FOF) or a multi-manager investment vehicle is a fund that invests in other funds. It is an investment portfolio that includes portfolios of other funds. They replace direct investments into stocks, bonds and other types of commodities, placing two additional funds between the investor and these direct investments.
What are the benefits of investing in FOF’s for diversification?
Funds of funds allow investors to invest in diversified portfolios that they otherwise would not be able to. Due to the additional fund layer, investors are required to make a smaller amount of capital available than if they were investing in a single fund or individual assets and commodities.
These funds also make professional fund selection and risk management available to investors. They are, therefore, the best option for those who do not have the knowledge to research individual funds to invest in or those who do not desire to do this. They are also perfect for those who do not know how to create strategies that help minimise investment risks.
Additionally they let investors diversify in alternative spaces. A professionally managed FOFs is an excellent option for investors who want to see whether investing in new spaces, marketers, or sectors is right for them.
Lastly, these funds make it easy to rebalance your portfolio without incurring high costs. Rebalancing typically requires that you sell some assets to buy others, and doing so is subject to capital gains tax. Since you have exposure to multiple funds, portfolio rebalancing within a fund does not attract capital gains, making it a less expensive option.
What are the fees associated with investing in funds of funds, and how do they compare to other investment options?
The fees charged include:
Annual management charge (AMC) or fee – Charged for selecting and managing the underlying funds. The AMC is typically a percentage of the assets under management.
Performance fee – Charged if the fund of funds outperforms a benchmark or achieves a certain level of return. The performance fee is typically a percentage of the excess return.
Expense ratio – The underlying funds in a fund of funds also have expenses, such as management fees and administrative costs, which they pass on to investors through the expense ratio.
Entry fee – A one-time fee paid when the investor buys shares in the fund.
Exit fee – A fee paid when the investor sells shares of the fund.
Other fees – There may be some additional fees, such as account maintenance fees, which are charged for managing the investor’s account.
These charges are similar to those of other investment options but have minor differences.
What are the differences between actively managed and passively managed FOFs?
Funds of funds are actively managed by a portfolio manager or team of managers who use their expertise to select and manage a portfolio of underlying funds that they believe will outperform the market or a specific benchmark. The managers of actively managed FOFs may also adjust the allocation of the underlying funds based on changing market conditions or investment opportunities.
Passively managed funds of funds aim to replicate the performance of a specific market index by investing in a portfolio of underlying funds that track the index. The allocation of the underlying funds is typically based on the weightings of the index components.
How do funds of funds differ from traditional investment funds, and what are their advantages for investors?
The main difference between FOFs and traditional investment funds is that FOFs invest in other funds, while traditional mutual funds invest directly in individual securities.
Additionally, funds of funds typically have higher fees than traditional mutual funds because they involve the additional fees associated with investing in the underlying mutual funds.
FOFs allow for better diversification. They expose investors to new markets, reduce risk and provide better returns.
FOFs are different from what many investors are used to, but they have legitimate benefits that make them perfect for all investors.
