What Is a Fund of Funds (FoF)?

A profitable portfolio must balance risk, diversification, return on investment (ROI), and predictable returns. Many investors need help juggling these priorities, which explains why they choose to invest in a fund of funds (FoF). 

Rather than buying shares in an individual mutual fund, exchange-traded fund (ETF), or hedge fund, an FoF allows you to invest in multiple funds simultaneously. Whether you’re a new or experienced investor, FoFs can diversify your asset allocation and help you reach your financial goals. 

What is a fund of funds, and how does it work? 

Also known as a multi-manager investment, an FoF is a pooled investment vehicle that invests in mutual funds, hedge funds, or other assets. Essentially, FoFs aggregate multiple fund portfolios into a single diversified investment. 

A fund manager runs the fund and allocates the capital invested by each limited partner (LP) in the fund. By investing in FoFs, LPs can invest in more asset classes and get access to professional managers with expertise in balancing diversification, risk, and ROI. 

Types of FoFs

FoFs are divided into two classifications: fettered and unfettered. Fettered FoFs invest only in funds issued by the FoF’s parent company, while unfettered FoFs can also invest in outside funds. 

Along with these primary classifications, FoFs can be grouped by their underlying strategy or asset class. Some popular FoF types include:

Target date funds

Target date funds, also known as life-cycle funds, automatically adjust asset allocations over time. At the start of your investment timeline, target date funds typically prioritize growth with greater weight given to equities. As you approach a specific date, these funds reallocate your portfolio between fixed income and equities to balance risk and returns.

Investors enjoy target date funds for their ease of use and convenience, making them popular with employer-sponsored retirement plans, such as IRAs and 401(k)s. Choose your fund, set a target date, and sit back as the fund goes to work rebalancing your portfolio.

Asset allocation funds

Asset allocation funds rank as the second most popular FoF type after target date funds. Funds like ClearShares OCIO ETF (OCIO) set specific percentages for bonds, stocks, and mutual funds based on the fund’s strategy. To maintain target ratios, asset allocation funds automatically adjust their asset mix at set intervals—often monthly or quarterly—or when allocations deviate outside an allowable range.

An asset allocation fund’s portfolio manager selects target allocations that help meet the fund’s goal. Goals vary from income generation to capital appreciation, and it’s the manager’s job to balance risk with long-term growth.

Asset allocation funds reduce risk by mixing securities from different regions, styles, and sectors to create the right fund for a particular strategy.

Hedge fund of funds

Hedge funds pool money from investors to buy investments that prioritize maximizing short-term capital gains. To achieve above-average ROI, hedge funds adopt high-risk strategies such as leveraging debt, short selling, and trading derivatives.

Most hedge funds only accept accredited investors—high net worth (or income) individuals or institutional investors like pension funds and endowments—making them inaccessible to many investors.

Non-accredited investors can participate in hedge funds by purchasing a fund of hedge funds. Hedge FoFs, such as Anfield Diversified Alternatives ETF (DALT), package one or more actively managed hedge funds into a tradable investment. A portfolio manager performs due diligence on behalf of investors by defining the strategy and selecting the funds for the FoF.

Investing in a hedge FoF gives you access to top hedge funds and professional expertise at a discount, plus greater diversification than a single hedge fund can provide, mitigating risk to your investment.

Private equity funds

Private equity firms raise capital to invest directly in distressed, new, or growing companies. Common private equity strategies include venture capital, buyouts, and growth equity. Private equity firms use financial modeling to identify undervalued companies ripe for investment, focusing on long-term gains rather than short-term profits.

A private equity fund of funds offers an alternative to traditional private equity investing. These funds invest in other private equity funds that purchase equity directly in private companies. Some private equity FoFs focus on specific regions or economic sectors, whereas others prioritize emerging markets or growing companies.

By investing in private equity FoFs, investors gain access to multiple firms and benefit from administrative efficiency, management expertise, and diversification.

Pros and cons of FoFs

Although FoFs offer many benefits, they aren’t perfect. Let’s take a look at the advantages and disadvantages of FoFs. 

Pros

• Diversification: FoFs grant investors access to diversified fund portfolios containing investments with different strategies, risk profiles, and styles. 

• Risk management: As layered investments, FoFs spread risk and reduce the chance that a poor-performing underlying asset will hurt the fund’s stability or growth. 

• Simplicity: With an FoF, you can invest in complex financial instruments without specialized knowledge or experience. 

• Convenience: By bundling multiple funds into one investment, FoFs make managing your portfolio easier.

• Liquidity: FoFs offer investors flexibility by providing daily liquidity, enabling more frequent trading. 

• Risk-adjusted returns: FoFs balance risk and returns by dividing resources among different asset classes. 

• Accessibility: Unlike hedge funds or private equity firms, which typically only accept accredited investors, FoFs give regular investors access to diverse portfolios of alternative investments. 

Cons 

• Higher fees: FoFs have higher expense ratios than single-manager funds because investors must pay the administrative fees charged by the FoF and the underlying fund investments. 

• Lack of control: FoF portfolio managers select which assets make it into the fund, meaning that individual investors have no control over asset allocation. 

• Double taxation: In some circumstances, FoF returns may be subject to double taxation, such as personal and corporate taxes or tax obligations in two countries, which eats into returns. 

• Performance lag: By prioritizing diversification and risk management, FoFs may underperform compared to the overall market or individual asset types such as mutual or index funds. 

Invest in FoFs with Composer

For years, only institutions and large, accredited investors had access to FoFs. Thanks to the advent of trading platforms like Composer, retail investors can now invest in FoFs from the world’s best-performing quant trading funds, private equity firms, and hedge funds.

Composer makes it easy to start trading FoFs. AI-powered trading algorithms allow you to build, backtest, and execute your strategy in minutes—all without specialized coding skills. 

1. Sign up to Composer for free

Visit Composer and click “Sign Up” to start your 14-day free trial. The free version allows you to access unlimited backtesting, follow lists, and symphony data and insights. 

Alternatively, you can enroll in a Pro plan for $24/month ($288/year) and unlock trading permissions, AI features, and real-time portfolio metrics.

2. Create a new symphony

To start trading FoFs with Composer, log in and select the “Create” button in the top left corner. Then, select “+ New Symphony.” On the create page, you can build your FoF strategy with our no-code editor or select “Create with AI” to develop FoF trading approaches using ChatGPT-4.

Just write a query asking for an FoF strategy, and our platform will handle the rest.

3. Start allocating

With your strategy in place, you can begin allocating weights to different asset classes. Mixing ETFs and stocks from discrete sectors and markets diversifies your portfolio and balances risk with returns.

4. Diversify your strategy

If you don’t know where to begin, select “Discover.” This will take you to Composer’s community page, where you can check out strategies made by our team and other Composer members. 

Tailor your strategy to focus on technology stocks, momentum trading, or diversification. You can even copy strategies touted by legendary fund managers like Warren Buffett and Ray Dalio. 

Whatever your approach, Composer has all the tools you need to take your FoF trading strategy to the next level.