Fund of Funds
A fund of funds is an investment fund that commits its capital to other funds — a portfolio of ten to thirty private equity or venture funds across managers, strategies and vintages — rather than to companies directly. It gives smaller investors diversification and access to managers they could not reach alone, at the cost of a second layer of fees; it is how many pensions first invested in venture.
- Also known as
- FoF, Fund-of-funds, Multi-manager fund
- Used at
- institutions too small to build a private-markets programme, investors entering a new geography or strategy, and access to oversubscribed venture funds that take only established LPs
- Binding
- a limited partnership like any fund; the fund of funds is the LP in each underlying fund and the GP to its own investors
- Typical fees
- 0.5–1% management fee and 5–10% carry on top of the underlying funds' 2% and 20% — the double layer that has shrunk the sector as large LPs went direct
- Typical portfolio
- 15–30 fund commitments over three to four vintage years; a diversified fund of funds rarely loses money and rarely returns more than 1.5–2×
- Parties
- the fund of funds manager, its investors, and the underlying fund managers, for whom it is one LP among many — and sometimes the anchor of a first fund
How a fund of funds works in practice
A €200m corporate pension wants private-markets exposure and cannot hire a team, evaluate a hundred managers or meet the minimum commitments of the best funds. It commits €20m to a fund of funds. The manager builds a portfolio: eight buy-out funds across Europe and the US, six venture funds, three growth funds, two secondaries funds, across three vintage years, with commitments of €5–15m each. It does the diligence on the managers, negotiates terms, manages the capital calls and distributions, and reports one line to the pension. The pension gets a diversified programme; the fund of funds earns its fee for the selection and the administration.
The cost is the layer. If the underlying funds return 2× gross, the underlying fees take it to about 1.7× net; the fund of funds' own fees take it to 1.5×. For an investor that could have gone direct, the layer is expensive; for one that could not, it is the price of access. The sector's response has been to move into what direct LPs cannot easily do — secondaries, co-investments alongside the underlying funds at no extra fee, first-time managers, emerging markets — and to shrink where the large LPs now invest directly.
For a venture manager raising a first fund, the fund of funds is often the anchor: an investor whose business is backing new managers, and whose commitment makes the next LP's possible.
Example
A fund of funds raises €400m and commits it over three years to twenty-two funds: twelve buy-out, six venture, four growth, with an average commitment of €18m. Ten years on the underlying funds have returned 2.1× gross and 1.75× net of their own fees; the fund of funds' 0.75% fee and 7.5% carry take the investors' return to 1.55× — €620m on €400m. The best underlying fund returned 4.2×, the worst 0.6×; no investor in the fund of funds lost money, and none made what the direct LPs in the 4.2× fund made. The pension that committed €20m received €31m over twelve years and, having learned the managers' names, committed directly to three of them in its next programme — which is the fund of funds' business model working against it.
Common mistakes
- Paying the double fee for diversification an LP is large enough to build itself. - A fund of funds so diversified that it cannot outperform the asset class after fees. - Reading the fund of funds' track record without asking which underlying managers it can still access. - Committing to a fund of funds for venture exposure and discovering it holds mostly buy-outs. - Managers taking a fund of funds as anchor without noticing its own investors' demands on terms.