The Nigerian mutual fund industry has come a long way. From one fund with less than N20 million in 1991 to over 100 funds spanning about 6 categories and over one trillion Naira. Nigerian investors and fund management companies deserve some kudos. The industry has equity funds, fixed income or bond funds, exchange-traded funds, Eurobond funds, and even target-date funds. One type of fund that seems to be missing from the roll call of funds is fund of funds.
What is a fund of funds?
A fund of mutual funds, or just fund of funds, is a mutual fund or hedge fund that invests in other mutual or hedge funds? So rather than investing in securities of different types like equities, bonds or treasury bills, a fund of funds buys into other mutual funds. It owns a percentage of another mutual or hedge fund. Fund of funds are also called multimanager funds because the fund manager of the fund of funds invests in funds being managed by other fund managers.
Why invest in fund of funds?
The major reason why an investor would like to invest in a fund of funds is to achieve a higher level of diversification. By investing in a fund of funds that invests in 4 other mutual funds comprising, for example, an equity fund, a fixed-income fund, a money market fund and a Eurobond fund, you are indirectly invested in all four funds. Another reason or advantage that will accrue to a fund of funds investor is that of reduced volatility.
As noted above, your investment in a fund of funds that invests in the four categories of funds noted above will not be as volatile as each of the funds because the high volatility of the equity fund, for example, will tend to be diluted by the low volatility of money market or fixed income fund.
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In addition to those advantages, by investing in fund of funds, the investor will have access to different fund managers with varying investment management experiences. Because the fund of funds manager does not just invest without appropriate due diligence, by investing in a fund of funds, an investor bypasses the need to do, and the pressure of doing, due diligence on funds.
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Disadvantages of fund of funds
As already noted, fund of funds investment presents advantages, but it does have disadvantages too. The major disadvantage is that of double layer of fees. Ordinarily, as an investor, you pay management, audit, admin, legal and other fees when you invest in a mutual fund. With investment in fund of funds, you will directly pay those fees in the fund of funds and indirectly pay those fees too in the different funds that the fund of funds invests in.
This double layer of fees can be removed or reduced, if the fund of funds manager can get favourably negotiated fees from the mutual funds it invests in. Although mutual funds in Nigeria are not transparent with the types of assets they invest in, investment in fund of funds increases that lack of transparency because more often than not, you only know what funds the fund of funds invests in and not what those other funds invest in. Given the general lack of transparency by Nigerian fund managers, that is not actually a disadvantage for a fund of funds investor.
Types of fund of funds
Fund of funds can come in different types depending on their investment focus. There could be private equity fund of funds, being a fund that invests in private equity funds, mutual fund of funds invest in mutual funds, fettered fund of funds are those that invest only in the funds being managed by the management company that is managing the fund of funds while unfettered fund of funds are allowed to invest in any fund, whether managed by the fund of funds investment management company or not.
The one additional advantage that derives from a fettered fund of funds is that the expense ratio is much less than that of unfettered fund of funds because since the fettered fund of funds is managed by the same fund management company, it does not charge double fees, and even when it does, it does so at a reduced rate.
Stanbic IBTC Asset Management is uniquely positioned to offer a fettered fund of funds to investors. This advantage or unique position comes from the fact that IBTC Asset Management has many funds spread across all strategies or categories that it will be easy to construct a fund of funds that the asset management company can oversee at little or no additional fees.
The Nigerian mutual fund industry has come of age, topping N1 trillion in asset under management, and given the level of investor education in Nigeria in relation to issues like investment diversification, Nigerian fund managers should think of ways to help the not so informed investors achieve diversification. One way to do that is to create a fund of funds as a mutual fund category in Nigeria.