What is a Fund of Funds?

A fund of funds (FOF) is an investment vehicle that pools investors’ money into a single portfolio.  A fund manager invests that collective money into multiple opportunities on behalf of the investors.  Think of it like a tree, where the roots represent individual investors, the fund acts as the tree trunk, and the various investments are the leaves.  Investors pool their funds together like roots gather water and nutrients from the earth.  The roots bring these essentials to the tree trunk, where they are funneled together and pushed up to the branches.  Eventually, the water and nutrients reach the leaves.  They are used to gather energy from the sun, which is then sent back down the tree to help it grow.  FOFs are kind of like financial photosynthesis.

The fund acts as an intermediary, collecting investment dollars from investors and dispersing them to individual opportunities.  As the investments pay their returns to the fund, those returns are distributed back out to the investors.  By pooling the funds and deploying them collectively, investors achieve three critical advantages over investing individually:

  • Diversification
  • Access to better investment opportunities
  • A mostly hands-off investment experience

FIRST:

First, and most importantly, consider the diversification provided by a private real estate FOF.  Investors who do not have millions of dollars to invest in many private real estate investments face a tough decision.  Do they accept significantly higher risk by investing in concentrated, one-off opportunities at ~$25,000 per investment?  Or do they stick to real estate investment trusts (REITs) or REIT exchange-traded funds (ETFs), where shares can be bought or sold in small increments?  With an FOF, investors can participate in the private real estate market but remain diversified in a similar manner to publicly traded mutual funds or ETFs.  

SECOND:

Second, by utilizing an FOF, investors can access some of the best sponsors in the industry.  Investors who do not have access to institutional-quality sponsors (whose minimum investment requirements often reach the millions-of-dollars mark) can join a fund that invests with the large sum of collective funds.  This provides access to sponsors who are generally out of reach for most investors, even accredited ones.

FINALLY:

Finally, an FOF can make the process of diversifying within private real estate a passive endeavor.  It can be daunting to actively seek out, vet, and invest in multiple private real estate opportunities.  Even on crowdfunding sites, you must carefully vet the sponsors, the property, the loans, and the platform itself.  By relying on a fund manager’s experience, established networks, and due diligence capabilities, an investor can achieve a far greater degree of diversification at a relatively passive pace.  And that is exactly what we are seeking as passive professionals: not only a return on our investments, but a return on our time.  

Find out more about fund of funds (FOF) investing in our No-Nonsense Guide to Investing in Private Equity Real Estate Funds.  At Cira Capital Group we curate diversified private real estate funds for busy professionals. 

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