What is a Fund of Funds?

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There is a relatively unknown subsection of the investment marketing industry called Funds of Funds (FOF). Recently these collective investment schemes have had some light shown on them as the Madoff scandal continues to disrupt the financial markets. Many of Madoff’s investors were actually FoFs. In this article I will explain what FoFs are and why they are generally a bad idea.

[VIDEO] What is a Fund of Funds?

A FoF is essentially a manager picker. That means that under the pretense of increasing the benefits of diversification the FoF manager will select other top performing fund managers to invest with rather than managing capital themselves. By spreading the FoF’s investors money across several managers the clients should enjoy greater diversification than otherwise available.

This would be great if those benefits actually materialized. The real problem with these funds are that they underperform other diversified investments and they have higher costs. For example, the Barclay’s Fund of Funds index shows that these products have returned 3% on average over the last 10 years compared to 6.83% on the S&P 500 over the same period. This ignores the additional problem of fees and expenses (which are considerable) that a Fund of Funds manager layers on top of the fees already charged by the underlying managers the FoF invests in.

Funds of Funds are illustrative of products that exist primarily for the benefit of the managers but provide little value to investors. There are many examples of this including actively managed funds and ETFs, most hedge funds and many professional advisors. The common denominator amongst these schemes is usually very high costs. In the case of a FoF these fees can be as much as 20% of profits and a percentage of capital invested. I think this is an excellent cautionary tale about considering costs versus benefits whenever you are making an investing decision.


This article is produced by Learning Markets, LLC. The materials presented are being provided to you for educational purposes only. The content was created and is being presented by employees or representatives of Learning Markets, LLC. The information presented or discussed is not a recommendation or an offer of, or solicitation of an offer by Learning Markets or its affiliates to buy, sell or hold any security or other financial product or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances and your investment objectives. Learning Markets and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.

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Investors should consider the investment objectives, charges, expense, and unique risk profile of an Exchange Traded Fund (ETF) carefully before investing. Leveraged and Inverse ETFs may not be suitable for all investors and may increase exposure to volatility through the use of leverage, short sales of securities, derivatives and other complex investment strategies. These funds’ performance will likely be significantly different than their benchmark over periods of more than one day, and their performance over time may in fact trend opposite of their benchmark. Investors should monitor these holdings, consistent with their strategies, as frequently as daily. A prospectus contains this and other information about the ETF and should be obtained from the issuer. The prospectus should be read carefully before investing.

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