- But, first: What is a fund of funds?
Also called a “portfolio of funds”, a fund of funds is different from a stand-alone mutual fund in that it isn’t invested directly in securities such as stocks and bonds. Instead, it holds a variety of stand-alone funds; these stand-alone funds are invested in the market. This is also different from a balanced fund, which is invested in various asset classes but, for the most part, holds securities directly.
- Focused on Diversification
With this type of product, mutual fund companies allow individual investors to diversify their investments among different asset classes with a single transaction and the same basic amount that they might invest in a stand-alone fund. To achieve an equivalent level of diversification, an individual, with the help of an advisor, would have to purchase many different funds. Some people prefer choosing particular stand-alone funds themselves and managing their own asset allocation. But a fund of funds approach offers an alternative for those who prefer to keep things simple.
- A Multi-manager Approach
Since each fund of funds consists of several funds, it ends up being managed by several managers, too, each one favouring a specific investment style, for example, “growth” investing or “value” investing. This multi-manager approach is generally thought to provide an additional level of diversification.
- A Portfolio for Every Investor
A portfolio of funds will usually be characterized by a specific risk profile, ranging from conservative to aggressive. So an investor can determine his or her own profile and then choose to invest in a corresponding fund of funds knowing that, in principle, the asset allocation will match the risk level that the investor is willing to accept.
- Regular Rebalancing
Finally, to ensure that the portfolio remains aligned with its risk profile, the company managing the fund of funds will look after rebalancing the asset allocation regularly to adjust for the variation in returns posted by the underlying funds. This means that the individual investor doesn’t need to do the buying and selling required to maintain the target asset mix.