If you’ve been investing long enough, you’ve probably heard of the investment vehicle known as a âfund of fundsâ. But how these products work and whether you should invest your hard-earned money in them isn’t always a straightforward question to answer.
As most people now know, exchange-traded funds have revolutionized low-cost investing, allowing investors with only a small nest egg to access strategies once characterized by high fees and exclusive access. . As a result, ETFs claim some $ 9 trillion in assets – and with over 7,000 total products listed around the world, finding the perfect fund for you in this sea of ââexchange-traded funds can be a daunting task.
In some ways, investing in funds of funds is deceptively simple. As with any other form of investing, you need to have a good idea of ââyour personal goals and tolerance for risk, and you need to make sure you research and verify anything before you buy. Here are some important things to consider when looking at the universe of funds of funds.
What is a fund of funds?
There are ETFs of all shapes and sizes available in 2021, and this variety makes it easy for ordinary Americans to bet on specific sectors, geographies or asset classes. However, this large number of funds has also caused a lot of confusion as it is difficult to decide what is right for you. And sometimes even this exhaustive list of funds may not be a perfect fit.
This is where fund of fund investing comes in. A fund of fund investment, sometimes referred to as a multi-manager investment by people in the company, is exactly what it sounds like – a fund that is made up of other funds. These holdings constitute the portfolio instead of investing directly in stocks, bonds or other assets.
A prime example comes from ETF giant iShares through its iShares Morningstar Multi-Asset Income Index Fund (ticker: IYLD), a $ 250 million fund of funds that seeks a portfolio with an asset allocation of 60% bonds. , 20% actions and 20% alternatives. assets with the aim of producing a diversified income stream. Its holdings include 12 other funds that individually focus on Treasury Bonds, Dividend Stocks, Real Estate Investments and more to give you this wide range. And you get it all for a net expense ratio of 0.60% – that’s just $ 60 per year for every $ 10,000 invested.
If you are an income oriented investor, chances are you will want to cover all of these areas. Just as putting all of your money into a single corporate bond or a single dividend-paying stock is incredibly risky, relying on a single asset class also comes with risk. A fund of funds is a simple and economical way to cover all your bases in one position to reduce complexity and confusion in a crowded ETF environment.
Build your own mix
Of course, under the regulations of the United States Securities and Exchange Commission, all ETFs – including funds of funds – must publicly report their holdings. So why not just research the IYLD wallet and replicate it yourself without paying iShares a dime?
It’s a good question. In fact, do-it-yourself portfolio management has a lot of potential benefits, including the ability to vary the allowances slightly to suit your personal taste. Perhaps the most obvious example is that the IYLD was only limited to iShares funds, but creating your own unhindered mix allows you to choose from the entire universe of fund providers. .
You can also sometimes save on costs, as some funds of funds actually charge you double billing by adding a management fee to the existing management fee for the underlying funds.
However, managing your own money requires a lot more practical attention. For example, as certain assets move up and down, you will need to ârebalanceâ your holdings to ensure that no position deviates too far from your target allocations. You will also need to manage the risk of choosing a lower quality fund that does not do what you expect, or the risk of managing when to enter and exit those individual positions if and when unexpected news arises.
For some investors, the cost of a fund of funds is well worth the peace of mind they get. And just like a lot of us pay someone to mow our lawn or do our dry cleaning, some Americans just don’t want to be hassled and think it’s money well spent to hire someone. else for details of regular portfolio management.
Advantages and disadvantages of investing in funds of funds
As you can see, funds of funds are neither good nor bad. They are just one more tool in the toolbox of individual investors which may be appropriate in some cases but not in others.
If you are interested in investing in funds of funds, you should start by asking yourself what strategy you are trying to deploy. Then, after doing your research, you should consider all of the options available based on factors such as:
- Annual fees: Is diversification worth the cost?
- Performance: Has the fund of funds generated satisfactory returns in the past?
- Maturity: When did the fund debut and is it âliquidâ with active trading volume and over $ 100 million in assets under management?
- Strategy: Is this the best way – or the only one – to achieve the desired strategy, or are there alternatives that seem better based on the previous criteria?
As with so many things on Wall Street, it’s all about “Watching the Buyers” when it comes to funds of funds. Understanding your goals and researching a product is essential before investing. However, funds of funds can indeed be a useful tool for some investors wishing to deploy a diversified and hands-off strategy.