A “fund of funds” is a general tern that can apply to stock funds, managed usually by an RIA (Registered Investment Advisor), to commodity funds managed by CTAs (Commodity Trading Advisors) and CPOs (Commodity Pool Operators), to mutual funds (managed by in-house employee managers) and to hedge funds (highly unregulated and managed by just about anyone.) “Fund of funds” just means that there is one entity (the fund) managing a collection of other entities (the funds). It’s like one manager managing many other managers. The funds can be structured as corporations, partnerships, limited partnerships or personal friendships with a trader and an analyst or just a trader, or with lots of superstructure of personnel. With this wide latitude you can see how broad the definition is. A fund of funds is just a single entity managing or selecting other entities to do the actual trading. A manager of managers is just what it says: one overseer manager selects a group of other managers, who manage the traders.
A manager of managers supposedly has the qualifications and experience trading, and the positive performance track record, to manage other managers who are selecting trading instruments including stocks, bonds, commodities and mutual funds.
Having a manager of managers is like having a president and several vice presidents. Hopefully, the president knows how to manage personnel and how to accomplish many or most of the tasks s/he will supervising. The vice presidents each might have specialties which they have gained through training and experience and they too will have skills in managing personnel. The managers under the vice presidents would then do the actual work, and/or have personnel working for them who would do the work.
The advantage of a manager managing managers is that the high degree of supervision should theoretically be self-disciplined and self-regulating. The manager of managers should know what pitfalls and short-comings to look out for and which statistics to watch to steer the funds’ performance. The manager of managers can “fire” or terminate a fund when the performance statistics are consistently low and hire other fund managers whose performance is more in line with the goals of the overall fund.
The first disadvantage is typically higher fees, as all the managers including the manager of managers need to get paid for their work. To pay steep fees of managing managers, the funds need to be large enough that a small percentage fee will still pay all the managers well. Small funds can accommodate the fees paid to a single manager, but it takes a large fund to pay many managers.
Another disadvantage of managers of managers is the timeliness of reports. As in any organization where there are levels of hierarchy, it takes time to accumulate data, conduct research, analyze the data, produce a report and present the report to management. This sort of super-structure might cause delays in reporting that could even lead to degradation of the funds performance.
While funds all use a benchmark for their performance, such as the S&P 500 or the Dow Jones 30 Industrials, they also look to each other for performance standards. Every fund wants to be the #1, best fund; so, they are all in competition for first place. At the same time, they are all in fear of being lower than the benchmark and as a result losing their clients. This will often lead the managers to hire new managers and fire under-performing managers based on previous performance. If the performance reports lag due to hierarchy, the manager of managers could easily be changing managers just at the time when their performance is improving.
There are books written on the value of statistics in following and judging the performance of managers of funds. These guidelines are often followed by managers of managers in an attempt to assure the high positive performance of the super-fund (or manager of managers of funds). However, the statistics are often just valuable for analyzing the past performance of a fund and not necessarily beneficial in predicting how well a manager of a fund is likely to do in the future. In fact, even the best of managers will hit a sore spot sometime in his/her future. There are many stories to tell of managers who have tremendously high performance – say double or triple digit returns for year after year, only to hit a market season that doesn’t mesh with his/her style of trading, or analysis. Such periods as the 2002-2003 market throw a wrench into every manager’s style, as they are often sudden and unexpected.
If you are a manager of managers the funds have to be large enough to accommodate the fees payable to the managers, and thus the size of the fund dictates that it can’t “turn on a dime” and change trading strategies quickly based on sudden market conditions. Many times a manager of managers will be held to contracts that give 30-90 days bail out clauses to the submanagers and this can cause delays in changing managers and thus diminish the performance of the over all fund.
Managers of managers is just another way of attempting to protect the public from single manager catastrophes, and yet it can burden the unsuspecting public with heavier fees and diminished performance.
MOM funds that have been in existence for more than three years, and who can show positive past performance than does better than the market in general (the benchmark), can fit well in a large portfolio. Small portfolios generally cannot accept the higher fees and are stretching for that “lucky break” that is often found in smaller funds. Generally, the larger the fund, the small the overall return, as they are less willing to take the risks that produce higher returns.
Links:
http://mutualfunds.about.com/od/educateyourself/a/fundmanager.htm
Mutual Fund Basics: http://mutualfunds.about.com/od/mutualfunds101/
Beginners Guide to Mutual Funds: http://mutualfunds.about.com/od/buildingblocks/
Ameriprise Financial: https://www64.americanexpress.com/om/comp/template/TemplateA.jsp