Types of funds of funds
There are two broad types of funds of funds: fettered and unfettered.
Fettered funds include only funds managed by the same company. For example, a fettered Vanguard fund of funds could invest only in funds managed by Vanguard.
Unfettered funds can invest in funds held by any company. An unfettered Vanguard fund of funds, for example, could invest in a Fidelity-managed fund.
Here are some narrower types of funds of funds:
- Target date funds: These funds of funds are the most popular. They’re designed for investors who don’t want to have to tinker with their asset allocation as important dates loom, such as retirement or a child’s college enrollment. As an example, people with money in a target date fund and who are nearing retirement might see their fund balance shift slowly from equities to bonds and other fixed-income investments.
- Target allocation strategy: Rather than focusing on the timing of a portfolio, these funds of funds focus on the mix within a portfolio. They set a specific balance of stocks and fixed income investments -- for example, 80% stocks and 20% bonds, or 50% stocks and 50% fixed-income assets.
- Hedge funds: Typically, only accredited investors are allowed to invest in hedge funds. But not every investor is a high-net-worth individual who can meet the criteria set by the Securities and Exchange Commission for risking money in a hedge fund. A hedge fund-oriented fund of funds can circumvent the restriction by allowing regular investors to put money into a mix of hedge funds.
- Business development companies (BDCs): These funds of funds were created to invest in small companies and distressed companies that are worth less than $250 million. These risky investments make money when companies decrease their debt loads or increase their stock prices. BDCs are considerably riskier than many other assets but are required to pay almost all profits to shareholders, similar to real estate investment trusts.
Of course, those aren’t the only types of funds of funds. International funds of funds that invest in global companies exist, as do exchange-traded fund-based funds of funds that specialize in ETFs. There are even gold funds of funds. Bottom line: If there’s more than one fund, it may be part of a fund of funds.
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