Fund of funds

A fund of funds is an investment vehicle that, instead of investing directly in companies, subscribes to units of other funds. In private equity, it lets an investor gain, in a single move, a diversified portfolio of Private Equity Fund, spread across several management teams, vintages, strategies and geographies.

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Its main appeal lies in diversification and risk pooling: exposure to a defaulting General Partner (GP) is diluted, and access to closed or hard-to-reach funds is eased. The fund of funds also offers an entry point for investors who have neither the size nor the analytical means to build a portfolio of primary funds themselves.

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For example, an investor commits 5 MCHF to a fund of funds spread across twelve underlying funds. Its exposure to a defaulting manager is diluted to around one twelfth of its commitment, at the cost of an additional fee layer weighing on net performance.

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Its counterpart is a double layer of fees: those of the fund of funds add to those of the underlying funds, which weighs on net performance measured by the TVPI – Total Value to Paid-In and the IRR – Internal Rate of Return. Assessing this gap between gross and net performance is at the heart of selecting a fund of funds.