A fund of funds or "FOF" is a type of investment fund that only invests in other investment funds. This means that the overall portfolio of investments it manages consists purely of other investment funds that may or may not be managed by the same company.
These funds offer unique advantages to smaller investors looking to benefit from better diversification options than they would otherwise have access to on the open securities market. However, investing in a fund of funds comes with its own set of challenges, not least of which is initially identifying a suitable FOF to invest in.
Many funds of funds have proven to be short-lived, and this can introduce an additional element of risk for new investors looking for a safer alternative to other forms of securities investing. A fund of funds must also be run by competent professionals with the necessary skills and discernment to allocate capital among other well-performing funds.
Types of funds of funds
Funds of funds are not all the same. They fall into two distinct categories, including:
Hedge funds of funds — This type of FOF is headed by a hedge fund that handles all the complicated business of investing in other funds on an investor's behalf. A hedge fund of funds gives investors access to professional investment experience and due diligence expertise that they are unlikely to have access to any other way.
Business development companies — These types of companies can turn their attention primarily to funds or invest pooled resources in a number of businesses, including other funds. Business development companies differ from a hedge fund of funds in that they are intended to help support smaller businesses and organizations coming out of difficult periods or poor performance periods.
A fund of funds is a pooled fund that invests exclusively in other funds, typically in hedge funds or mutual funds. These funds are ideal for new and smaller investors who desire the added protection of diversification. Investors in funds of funds also benefit from the expertise of multiple fund managers.