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With the explosive growth in exchange-traded funds, many investors expect to find nearly any investment they want in ETF form. Now, ETF managers have borrowed a concept from hedge funds and their mutual fund cousins by creating ETFs that are specifically designed to hold shares of several other ETFs.

In May, PowerShares introduced three balanced funds of funds, including the PowerShares Autonomic Balanced Growth NFA Global Asset Portfolio (PAO). Rather than buy stocks or bonds directly, these FOFs invest their assets in other ETFs. The advantage of these FOFs is that investors can achieve extremely broad diversification with one investment.

Fund facts

  • Inception date: May 20, 2008
  • Expense ratio: 0.25%
  • Net assets: $8 million

Fund specifics
Between the Balanced Growth fund and the two other PowerShares FOF offerings -- PowerShares Autonomic Balanced NFA Global Asset Portfolio (PCA) and PowerShares Autonomic Growth NFA Global Asset Portfolio (PTO) -- investors can select an equity/bond mix of 60/40, 75/25, or 90/10. Each fund is benchmarked to a New Frontier Global Dynamic Index, which is made up of ETFs, most of which are other PowerShares funds. Along with typical investments like large-cap stocks and investment-grade bonds, the Balanced Growth fund also includes exposure to gold, microcap stocks, and high-yield corporate bonds.

All three funds have about 30 holdings and charge an expense ratio of 0.25% on top of the fees the underlying ETFs assess. Because the top holdings of these funds come largely from the PowerShares family of ETFs, which are not usually at the lowest end of the fee spectrum, the total costs can be fairly substantial.

Because the Balanced Growth fund is a mix of equity and fixed-income ETFs, there's a risk that the market segments that the underlying assets represent may underperform the overall market. Investment in the underlying ETFs also subjects these funds to all of the usual equity and fixed-income risks.

Drilling down, you'll find that the actual stocks this fund owns indirectly through its ETF holdings are the typical companies you'd expect to see in a diversified portfolio. Through holdings in the PowerShares Dynamic Large-Cap ETF, investors own shares of Qualcomm (Nasdaq: QCOM  ) , Procter & Gamble (NYSE: PG  ) , and McDonald's (NYSE: MCD  ) , among dozens of others. International holdings include Novartis (NYSE: NVS  ) and Royal Dutch Shell (NYSE: RDS-A  ) . You also get a dose of small caps, such as Olin (NYSE: OLN  ) and Longs Drug (NYSE: LDG  ) .

Portfolio fit?
The broad diversification of the Balanced Growth fund means that it can serve as the core of your portfolio. If you want to put your ETF investing on automatic, this one-stop approach may be just what you're looking for. Yet since the FOF structure includes fees at both the underlying fund and the FOF level, the overall cost can be relatively high. Investors willing to build their own diversified portfolio of ETFs and spend the time monitoring and adjusting their investments should be able to achieve similar diversification and risk levels at a lower price.

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Fool contributor Zoe Van Schyndel lives in Miami and enjoys the sunshine and variety of the Magic City. She owns none of the funds or securities mentioned in this article. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

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10/30/2008 4:07 PM
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