Fund of Funds (FOF): Definition, Benefits & Risks
- Lukas Müller, PhD
- Oct 21
- 3 min read
A Fund of Funds (FOF) is an investment vehicle that holds a portfolio composed of other funds rather than investing directly in individual securities. This approach provides investors with broad diversification, professional management, and simplified access to multiple investment strategies or asset classes through a single investment product.
What Is a Fund of Funds (FOF)?
A Fund of Funds, often abbreviated as FOF, is designed to invest in a collection of other mutual funds, hedge funds, private equity funds, or ETFs. Instead of selecting individual stocks or bonds, the FOF manager allocates capital across various funds managed by other professionals.
This multi-layered structure enables investors to gain exposure to a wide range of markets and investment styles, reducing single-manager or single-asset risk. However, it also introduces additional costs since investors pay management fees at both the FOF and underlying fund levels.
How a Fund of Funds Works
In practice, an FOF serves as a meta-fund. The manager performs due diligence to select high-performing funds that align with the fund’s objectives whether that’s growth, income, or risk mitigation.
For example, an equity-focused FOF might invest in several large-cap, mid-cap, and international mutual funds, while a hedge fund FOF could combine strategies like long/short equity, global macro, and event-driven approaches.
By investing across multiple funds, the FOF spreads exposure across different asset classes, sectors, and management styles helping reduce unsystematic risk.
Types of Fund of Funds
FOFs can vary depending on their investment focus:
Mutual Fund of Funds: Composed primarily of open-ended mutual funds for retail investors.
Hedge Fund of Funds: Targets accredited investors seeking diversified exposure to hedge fund strategies.
Private Equity Fund of Funds: Invests in multiple private equity partnerships to access institutional-quality deals.
Exchange-Traded Fund of Funds (ETF FOF): Uses ETFs to replicate broad market or tactical exposures efficiently.
Each type caters to different investor profiles and liquidity needs.
Benefits of Fund of Funds
The FOF model offers several key advantages:
Diversification: Reduces concentration risk by spreading investments across managers and strategies.
Professional Selection: Leverages fund managers’ research and due diligence.
Accessibility: Provides entry to hedge funds or private equity funds typically limited to large investors.
Convenience: Simplifies portfolio construction by outsourcing fund selection and rebalancing.
For investors who prefer a hands-off approach, an FOF can serve as a turnkey solution to achieve multi-asset diversification.
Risks and Drawbacks
Despite its benefits, the FOF structure carries certain challenges:
Double Layer of Fees: Investors pay management fees for both the FOF and the underlying funds.
Overlapping Holdings: Different underlying funds may hold similar securities, reducing diversification benefits.
Limited Transparency: Some hedge fund FOFs may not disclose all holdings or strategies.
Liquidity Constraints: Private equity or hedge fund FOFs often have long lock-up periods.
Because of these factors, FOFs may not be ideal for cost-sensitive or short-term investors.
Example of a Fund of Funds
Consider an investor seeking global diversification. Instead of building a complex portfolio, they purchase a global balanced FOF. The manager allocates across U.S. equity, European fixed income, and Asian growth funds. This gives the investor diversified global exposure through a single investment, managed by professionals at both levels.
Who Should Invest in a Fund of Funds?
FOFs are particularly suitable for:
Investors seeking instant diversification with minimal effort.
Those lacking the time or expertise to select and monitor individual funds.
Institutional investors aiming for exposure to alternative asset classes through managed vehicles.
However, investors should evaluate total expenses and ensure the benefits of diversification justify the additional costs.
Conclusion
The Fund of Funds (FOF) structure provides an efficient gateway to diversified, professionally managed portfolios across multiple asset classes. While higher fees and potential overlap are considerations, the model remains a powerful tool for investors prioritizing broad exposure, convenience, and expert management.
When used strategically, a Fund of Funds can serve as a well-rounded, one-stop solution for long-term portfolio diversification.
