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Funds for Uncertain Times: Funds of funds

What funds can help you move forward in these uncertain times? 

These are different times, unlike any we’ve seen before, so it makes sense to consider different kinds of investments. 

So far, we’ve looked at how alternative funds could help you manage stock market volatility and today’s low bond yields. 

And why many investors and advisors are turning to sustainable funds in 2020’s unpredictable markets.

Six FAQs about funds of funds

Here’s another kind of fund that could help you simplify your investing and avoid having to keep up with every shift in 2020’s volatile markets: They’re called funds of funds. 

Millions of investors own these in their retirement accounts, but they may not fully understand how these funds work. So we asked FundX investment advisors (many of whom have managed funds of funds for years) to answer some key questions, including: 

  • What is a fund of funds?
  • Is this a new kind of investment?
  • How do these funds work?
  • Are funds of funds the same as hedge funds?
  • How could a fund of funds help me invest in uncertain times?
  • What are some examples of a fund of funds?

What is a fund of funds?

A fund of funds is simply a mutual fund that invests in a portfolio of other mutual funds or exchange-traded funds (ETFs). Investors can own a full portfolio of funds in one fund purchase.

Funds of funds are also occasionally referred to as multi-manager investments. 

As Investopedia put it, “an [fund of fund] FOF gives the little guy the professional management and diversification that have often been reserved for the wealthy.”

Is this a new kind of mutual fund? 

Nope. Funds of funds have been around for decades, and there are more than 1,400 of them available today, according to the Investment Company Institute (ICI) data. Most are hybrid funds of funds (1,248), meaning that they invest in both stock and bond funds. Others invest solely in stock funds (167) or bond funds (54). 

ETF funds of funds—ETFs that own a portfolio of other ETFs—are fairly new, and there are fewer to choose from. The Wall Street Journal reported cited Morningstar data that “at the end of November [2019], there were 99 ETF funds of funds registered in the U.S., up from 48 at the end of 2014.”

How does a fund of funds work?

Funds of funds work like any other mutual fund. Fund managers build, monitor, and manage a portfolio to meet a certain investment objective. And investors can buy and sell funds of funds at most brokers and through many retirement plans as well. 

Funds of funds tend to have higher expenses than an individual fund because they include the expenses of the fund of funds and the expenses of the underlying funds in the portfolio.  

“The strategy of investing in a fund of funds aims to achieve broad diversification and asset allocation where investors can get broader exposure with reduced risks compared to investing directly in securities,” Corporate Finance Institute noted.

Are funds of funds the same as hedge funds?

No. Some hedge funds invest in other hedge funds, but they aren’t the same as mutual funds that invest in other funds and ETFs. 

As FINRA, the financial industry regulatory authority, points out: “Funds of hedge funds generally invest in several private hedge funds that are not subject to the SEC's registration and disclosure requirements ... many of the normal investor protections that are common to most traditional registered investments are missing.” 

Mutual funds, on the other hand, are registered investments that are regulated under the Investment Company Act of 1940. Mutual funds are required to disclose their holdings and the potential risks of their strategies; hedge funds aren’t.

How might a fund of funds help investors in 2020’s uncertain markets?

Funds of funds can help simplify your investing, so you don't have to worry about keeping up with every shift in the markets. They “can make life easier for individuals who don’t want to spend a lot of time thinking about their investments,” the Wall Street Journal explained.

So if you’ve been feeling overwhelmed with trying to keep up with 2020’s rapidly changing markets, owning a fund of funds could give you some much-needed peace of mind. 

With many funds of funds, you can get a professionally managed portfolio without having to meet an advisor’s high minimum investment. (Many can be purchased for as little as $2,500.) This means that you don’t have to decide which funds to own now or when to move on to other funds. And you don’t have to worry about broker trading fees or remember to rebalance your positions. It’s all done for you.

Additionally, at tax time, you only have to deal with year-end distributions from your fund of funds, not the income or gains distributed by the underlying funds.

Funds of funds offer instant diversification, and that could help the explosion of new investors who opened new brokerage accounts in 2020. “If you only have a small amount of money to invest each month, a fund of funds allows you to access more funds than you may be able to do on your own,” Morningstar noted. 

why invest in a fund of funds

What are some examples of a fund of funds?

Here are examples of three different kinds of funds of funds: 

Target-date funds 

Target-date funds, which are designed to meet a specific retirement date, are perhaps the most common fund of funds. “Millions of Americans contribute part of their salaries almost daily into these funds-of-funds, which are mostly held in 401(k) plans,” Barron’s reported. 

Example: Fidelity Freedom funds, Vanguard LifeStrategy Funds. Vanguard LifeStrategy Moderate Growth Fund (VSMGX), for example, invests in four other funds.

Fettered Funds of funds (limited to one fund family)

Funds of funds that only invest in other funds from the same fund family are called “fettered” funds. 

Example: Vanguard STAR (VGSTX) is a balanced fund that invests in a portfolio of 10 other Vanguard funds. T. Rowe Price Spectrum Income (RPSIX) invests in other T. Rowe Price funds.iShares Moderate Allocation (AOM) is an ETF that has a fixed allocation to stocks and bonds. AOM invests only in other iShares ETFs and BlackRock funds. 

Unfettered fund of funds (invest in many fund families)

“Unfettered” funds of funds can invest in funds from many fund families, which means that they can take advantage of opportunities from many different fund managers and investment strategies. (Full disclosure: We manage a series of unfettered funds of funds.)

Example: BNY Mellon Alt Diversifier Strategies (DRNIX). BMO Growth Allocation (BABHX) invests in BMO funds, as well as funds from Vanguard, Dodge and Cox, Harbor, Federated and others. 

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