As an investor, deciding how best to allocate your capital can feel overwhelming with the multitude of options available in today’s markets. One approach that has gained popularity is investing in “funds of funds”, otherwise known as multi-manager funds. Rather than putting all your eggs in one basket, funds of funds give exposure to a portfolio of different investment funds run by specialist managers. This diversification can help reduce risk while still pursuing attractive returns. However, navigating the funds of funds landscape takes savviness. This beginner’s guide will break down the basics of how they work and how to approach investing confidently in this space.
Understand The Structure
Funds of funds invest your money into a selection of other investment funds instead of directly into stocks, bonds, or other securities. The fund of funds manager conducts deep research to identify top-performing underlying funds run by talented asset managers. Your capital is then distributed among this portfolio of independently managed funds. The fund-of-funds structure provides instant diversification across multiple strategies, managers, and asset classes simply by purchasing one product. Fees are involved at both the fund of funds level and underlying funds level, so costs are higher than investing directly.
Evaluate Investment Strategies
Funds of funds can invest in different asset classes and use varying strategies. Some focus exclusively on alternative investments like hedge funds and private equity, aiming to generate absolute returns regardless of market conditions. Others specialize in public equities, fixed income, or real assets. Examine carefully a fund’s stated strategy and ensure it aligns with your objectives, risk tolerance, and investment horizon. Well-constructed portfolios provide exposure across diverse managers pursuing complementary styles for reduced volatility. Beware of funds with a too narrow or loosely defined focus that sacrifices diversification.
Perform Diligent Manager Research
Thorough evaluation of the fund of funds management team is just as pivotal as analyzing the underlying funds. Experienced professionals with strong track records are best equipped to identify high-quality managers, construct optimal portfolios, monitor investments closely, and make changes promptly as needed. Consider the tenure, resources, investment philosophy, portfolio construction approach, risk management processes and performance history of the manager over full market cycles. Numerous manager changes or inconsistent performance could portend future difficulties.
Real Estate Investing Fund Of Funds
One popular specialized strategy is real estate investing fund of funds, which provide exposure to commercial and residential properties across geographies. These funds pool investor money and allocate it to REITs, private equity real estate funds, and other real asset investment vehicles run by real estate experts. Investing through a real estate fund of funds lets smaller investors access large, institutional-type property investments typically reserved for deep-pocketed limited partners. The real estate asset class benefits risk-averse beginners due to its non-correlation to stocks and protection against inflation.
Analyze Fee Structure In Depth
Funds of funds layer on extra costs compared to direct investments since fees are charged at both levels. Investors must scrupulously analyze the fee schedule to ensure they are not paying excessively relative to the added benefits. Total annual fees including fund of funds management fees, underlying fund fees, performance fees, and other costs should not surpass 2-2.5% for most strategies. Be leery of funds with fees above this range, as costs will significantly impact long-term performance. Negotiate fees, when possible, with a large investment amount.
Consider Minimum Investment
While minimums vary, many reputable funds of funds require at least $100,000 or occasionally higher to gain exposure. This upfront capital allows the manager breathing room to construct a stable, diversified portfolio right away. Investors with investible assets under $100k should focus on direct mutual funds until they amass more savings. Beginning with too small an allocation into funds of funds risks the account being very concentrated, undermining diversification benefits. Minimums are ordinarily negotiable for very large ticket sizes.