Money: For those who don't like risks

Funds of funds give diversity but are costly, says
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The Independent Online
fund of funds does what the name suggests - it's an investment fund which uses your cash to buy a stake in other funds which perform well. Normal collective funds use your money to buy shares, so a fund of funds is a more cautious approach.

There are good arguments in favour of putting your money into a fund of funds (there are now more than a hundred of them) and they revolve around two central tenets of investment - expertise and diversification.

As a lone investor, you're confronted by hundreds of unit and investment trusts to choose from. Doing your homework, making a selection, then staying abreast of your funds' performance can be a daunting business. So why not leave it to the professionals?

"We believe that we can do a better-than-average job of choosing and monitoring unit trusts," says Tim Miller, managing director of fund-of- fund specialists Portfolio.

The second point is that funds of funds also help to spread risk by providing a double layer of diversification. A fund of funds portfolio containing 12-15 high-performing unit trusts - a kind of financial Russian doll - each of which has perhaps 100 shares, means that your money is spread across more than a thousand companies; in the case of an internationally based fund, it will also be distributed throughout many different markets. So there may be problems in one share, industrial sector or region, or even internal problems with a particular unit trust - but it only affects a small part of your investment.

That is particularly valuable for small investors with only a one or two thousand pounds to spare and who are not in a position to create their own unit trust portfolio: "Even with pounds 10,000 to invest, it's difficult to get proper diversification; with only pounds 1,000, it's impossible," observes Mr Miller. The downside to the whole arrangement is the cost. The double layer of unit trust management means a double layer of charges.

"It's possible to minimise costs," says Mr Miller. "We make a 5 per cent initial charge but we can generally buy our underlying trusts without paying their front-end charges because we take such large quantities, and we'll also get rebates on the annual fees. But the total cost will be higher than for a single unit trust."

Portfolio works out its charges by averaging all the initial and annual charges involved; the cheapest of the range is the flagship Fund of Funds, with an upfront charge of 5.02 per cent and an annual fee of 1.828 per cent, which is steep compared with the 1 per cent to 1.5 per cent per year levied by most ordinary unit trusts.

Other managers - M&G, for instance - are cheaper because they limit their investment options to in-house funds and thereby cut out a layer of expense. Fidelity, whose Moneybuilder Plus invests in Fidelity's own global range of oeic sub-funds with a view to capital growth, levies no up-front charge at all and an annual management fee of around 1.75 per cent. It is worth noting that Fidelity's Moneybuilder fund has turned out top-quartile performance every quarter since its launch in 1988.

The in-house fund of funds manager can get to know the range, and the managers running each one, much better than a manager with access to the whole spectrum of out-of-house funds. On the other hand, if you want to spread risk within a specific geographical region, you would need to look for a product investing in the specialist unit trusts of a number of fund managers. If you want this potential exposure to the full universe of unit trusts, you will have to pay for it and hope stellar performance makes the charges look reasonable.

So does a fund of funds justify the additional expense? Amanda Davidson, of London-based IFA Holden Meehan, steers clear of them on principle: "We prefer to choose individual unit trusts for clients - we like a more bespoke approach and more control over the choice of investments. And on top of that, there's the double charging structure."