Fund of hedge funds

A "fund of funds" (FOF) is an investment strategy of holding a portfolio of other investment funds rather than investing directly in , bonds or other securities. This type of investing is often referred to as multi-manager investment. A fund of funds may be "fettered", meaning that it invests only in funds managed by the same investment company, or "unfettered", meaning that it can invest in external funds run by other managers.

There are different types of FOF, each investing in a different type of collective investment scheme (typically one type per FOF), for example a mutual fund FOF, a hedge fund FOF, a private equity FOF, or an investment trust FOF. The original Fund of Funds was created by Bernie Cornfeld in 1962. It went bankrupt after being looted by Robert Vesco.

Investing in a collective investment scheme may increase diversity compared with a small investor holding a smaller range of securities directly. Investing in a fund of funds may achieve greater diversification. According to modern portfolio theory, the benefit of diversification can be the reduction of volatility while maintaining average returns. However, this is countered by the increased fees paid both at FOF level and at the level of the underlying investment fund.

Management fees for FOFs are typically higher than those on traditional investment funds because they include the management fees charged by the underlying funds.

Pension funds, endowments and other institutions often invest in funds of hedge funds for part or all of their "alternative asset" programs, i.e., investments other than traditional stock and bond holdings.

After allocation of the levels of fees payable and taxation, returns on FOF investments will generally be lower than what single-manager funds can yield.

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