What are Funds of Funds (FoFs)?

Funds of funds (FoFs) pool money from various investors to invest in other funds. They were built to make investing more convenient. While ETFs and mutual funds invest in pre-decided assets as per a set strategy, they still require investors to construct a portfolio by choosing which funds to hold.

FoFs eliminate this hassle by allocating money across different funds as per a particular strategy or investor profile.

They can either be fettered FoFs that invest solely in funds managed by the same asset management company (AMC) or unfettered FoFs without such restrictions. Since PE and VC funds are fewer than public market funds, most FoFs in these asset classes are unfettered.

In this article, we will explore the different types of FoFs in private markets, their benefits, and key considerations.

Another type investors should note is the target date FoF. These funds invest in private markets with the same target exit date, allowing for better investment tracking and visibility regarding exits.

Why Invest in FoFs?

Private market FoFs are geared towards investors who are newcomers to the complexities of venture capital and private equity. FoFs make these asset classes more accessible and easier to manage in the following ways:

Professional Portfolio Management

Investments into private equity and venture capital are inherently riskier and more sophisticated than stock market investments. Each PE and VC fund provides exposure to multiple, complex equity instruments of different companies.

When you invest in such assets, managing an individual portfolio’s risk exposure and return potential can be extremely challenging, especially for those who aren’t full-time investors.

FoF managers take this concern off your plate by continuously monitoring fund performance, rebalancing allocations, and adjusting exposure based on market conditions.

Better Manager Selection

As a newcomer to VC and PE funds, it is easy to get swayed by big names and lofty credentials. However, professional FoF managers know which questions to ask and which credentials actually matter. They have established relationships with top-tier fund managers, access to detailed track records, and the expertise to evaluate fund strategies and historical performance metrics that individual investors may overlook.

Easy Diversification

Private market funds have extremely high minimum investment amounts, making it challenging to diversify across industries and geographies. FoFs are the tailor-made solution for this challenge.

While a single PE fund might require a $10 million minimum investment, an FoF may offer exposure to 10-15 different funds for the same commitment, spreading risk across multiple strategies, vintages, and geographies.

Access to Exclusive Funds

Certain VC and PE funds demand higher minimum investment amounts and financial sophistication, even by private market standards. Individual investors often cannot directly invest in these funds and must invest indirectly through FoFs. Top-quartile managers frequently close their funds to new investors or maintain strict institutional-only policies, making FoFs the only viable access point.

Enhanced Liquidity

FoFs have a relatively active secondary market compared to individual company shares received via PE and VC funds. As an investor, you do not need to wait a decade to realize gains from your private market exposure. While still less liquid than public markets, FoF interests trade more frequently than direct fund positions, providing an exit option if capital needs change.

Drawbacks and Considerations Before Investing in FoFs

Despite their convenience, FoFs can prove to be a poor fit for you because of the following reasons:

Irregular Updates and Reporting Challenges

Each private market fund may have a different reporting schedule and standards. As a result, FoF NAVs may often be inaccurate or outdated, and investors may need to verify how many constituents have updated the FoF manager regarding the latest period’s financials. This reporting lag can range from 45 to 90 days, making real-time portfolio assessment difficult.

Double-Layer of Fees

A common criticism of FoFs is the double-layer of fees. Investors can make returns only after management fees and carried interests are paid to both the constituent funds and the encompassing FoF.

Let us understand this with an example. Suppose both underlying funds and the FoF charge 2% management fee and 20% carried interest (the ‘2 and 20’ model).

For the sake of simplicity, we will also assume a hurdle rate of 0%. So, GPs of both levels of funds can receive carried interest as long as the fund breaks even.

Particulars	Direct fund investment	FoF investment
Initial investment	$1,000,000	$1,000,000
NAV at distribution	$2,000,000	$2,000,000
Underlying fund’s management fee (2%)	$40,000	$40,000
Profits after the underlying fund’s management fees	$960,000	$960,000
Underlying fund’s carried interest (20%)	$192,000	$192,000
Proceeds after accounting for the underlying fund's fees	$1,768,000	$1,768,000
FoF’s management fees (2%)	N.A.	$35,360
Profits after FoF management fees	$1,768,000	$1,732,640
FoF’s carried interest	N.A.	$346,528
Net returns to the investor	$1,768,000	$1,386,112
Effective returns	76.80%	38.61%

The above example shows how the double-layer fee structure can effectively halve the investor returns.

Varying Investment Schedules and Capital Call Timing

Unless you invest in a target date FoF, your FoF likely responds to capital calls at different stages for each constituent fund, creating significant disparities in distributions received. Ultimately, this impacts the exit investors can expect from the FoF itself.

Eqvista – Transparency That Drives Performance!

Funds of funds offer a practical gateway to private markets for investors seeking diversification, professional management, and access to exclusive opportunities. However, the convenience comes at a cost through layered fees and reporting complexities that can obscure true portfolio performance.

Whether you’re an LP evaluating FoF opportunities or a GP managing a fund of funds structure, accurate and timely valuations are essential to understanding real returns and making informed allocation decisions.

Eqvista provides comprehensive cap table management and portfolio valuation services that bring clarity to complex fund structures. Our platform delivers real-time insights that help you track performance across multiple fund layers, assess fee impacts, and communicate value transparently to your investors.

Contact us to know more!