A collective investment schemes what we call as an investment funds uses an investment strategy which includes holding a portfolio of other investment funds instead of directly investing in securities and shares or bonds. This type of investment is a good example of multi manager investments. Different funds are invested in different investing schemes or funds like, mutual funds, hedge funds or even an investment trust. When investing in any collective investment schemes, investment would increase greatly as compared to any small investor. And investing in fund of funds would achieve even a greater diversification.
Any investment manager would very actively manage investments by selecting bad securities. But a fund of funds manager would only try to select best performing funds to make an investment. So if the manager is very skillful, it could provide even a greater stability and take on some of the risk relating to the decisions of the manager. Fund of funds are often used in investment in hedge funds and private equity funds as they have a very minimum investment levels when compared to traditional investment funds. The lack of accessibility favors a fund of funds with a professional manager and build in spread of risk. Pension funds also invest in find of hedge funds other than traditional stock and bond holdings.
The fund of hedge funds invest in portfolio of different hedge funds as it provides a broad exposure to hedge fund industry and also diversifies the risk associated with the single investment fund. After selecting the manager a portfolio is constructed based on the selections. The fund is solely responsible for hiring and firing the managers in the fund. The fund generally charge a fee for their service in addition to hedge fund management and performance fees. While fund of funds can provide very useful services for many hedge fund investors, but still they have been criticised for incrementing the cost they impose. One of the defining characteristics of hedge funds are the performance fees which gives a share of positive returns to the managers. It is calculated as a percentage of the fundís profit. Investors are usually willing to pay managers more performance fees as the investors have themselves made money. So this fee acts lucrative for managers who perform well.
Some managers would even charge investors with a withdrawal or a redemption fee if the investors withdraw the money from the fund before a certain period of time has elapsed since the money was invested for the purpose to encourage long term investments in the funds.
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