The mutual-fund universe offers plenty for investors.
Thousands of different funds focus on a variety of subjects: growth, value, Internet, technology, large and small companies, just to name a few.
But suppose you want to own a wide range of funds but can only afford one.
Consider a fund of funds (FOF).
These funds max-out diversity by buying shares of a variety of mutual funds.
"A fund of funds is a ready-made mix of funds, the type of asset allocation between different types of investments that you would get if you went to a professional money manager," says Larry Solomon, director of research for the No-Load Fund Investor, a newsletter. "So, if you have enough money to buy just one mutual fund, a well selected fund of funds might be a smart investment," he says.
"For beginning investors, a fund of funds is a good start," - a mutual fund "starter home," says Amy Granzin, who tracks a number of such funds for Morningstar Inc., a financial information-firm in Chicago. "If you have limited resources, this type of fund gives you access to other funds at the same time," she says.
Major companies such as Vanguard, Fidelity, T. Rowe Price, Scudder, and Charles Schwab all offer FOFs.
Some, like Schwab, hold diverse funds from different fund families. Others, like Vanguard and Fidelity, invest in funds from within their own families.
But either way, an FOF investor holds not just a portfolio of companies - but a portfolio of mutual funds. The result is a more diverse portfolio and greater security against major losses.
Still, FOFs often come with high expenses and seldom come close to beating the market, experts say.
Evidence suggests that FOFs tend to do better in market slumps than regular mutual funds. Thus, many earn high scores for safety.
In the bear-market downturn of 1987, for example, the average mutual fund lost almost 30 percent, according to Morningstar. But the average fund of funds lost only 20 percent.
And if it's a great manager that you are looking for in a mutual fund, FOFs can offer you any number of managers - all from other funds. Many FOFs themselves are run by an overseer, or committee, as opposed to an active manager.
Which leads to their negatives. "They can be very expensive, and, being middle-of-the-road conservative funds, they provide only average returns," says Ms. Granzin, of Morningstar.
The biggest woe: You can be socked with a double bill from your fund company.
Some companies charge not only management expenses for your FOF but also prorated management costs from the funds that make up your fund of funds.
The typical management expense for a fund of funds is about 1.5 percent, somewhat higher than a typical stock fund, which can often go as low as 0.8 percent.
Generally, says Granzin, you will come out ahead by buying a fund that invests in its own funds, such as Vanguard's Star Fund.
Star is believed to be the oldest existing FOF, starting up in 1985. Star does not charge a double bill. It also differs in being a balanced fund, holding both bond and stock funds.
Currently, Star is invested in nine other Vanguard funds. And you can invest in Star for only $1,000 in a regular account. This is the only major Vanguard fund that does not require a $3,000 minimum investment for regular accounts.
According to ValueLine, Star is invested about 63 percent in equities, 25 percent in bonds, and 12 percent in cash.
Funds of funds started out in the late 1960s and early 1970s as the black sheep of the mutual-fund industry - the product of infamous speculator-promoter Bernie Cornfeld.
Mr. Cornfeld, whose picture often appeared in celebrity magazines on yachts surrounded by a bevy of scantily clad young women, founded a fund called the "Fund of Funds," as part of his Investor Overseas Services, a fund outfit with offices in the Caribbean.
But Cornfeld's celebrity photo turned into a mug shot: He wound up in jail for securities fraud. Investors saw their savings disappear.
An indignant US Congress subsequently restricted the ability of mutual funds to invest in other funds. But since then, federal regulators have eased off their hard-line stance. And funds of funds have made a comeback this decade.
Today there are slightly fewer than 100 FOFs, counting multiple share classes.
Most of these have not been around long enough for either Morningstar or ValueLine to give a three- or five-year performance assessment (see table, below).
Funds of funds
A fund of funds is simply a mutual fund that invests in other mutual funds.
These funds offer investors greater portfolio diversity. But because of their conservative nature, their returns are often low. The average return of these funds so far this year is about 5 percent. Below are the top performers in this category. TOTAL RETURN
FUND NAME YTD 1-YR. STAAR ALTERNATIVE CATEGORIES 15.3% 10.4% 412-367-9076
FEDERATED INTL. GROWTH A 14.7 10.9 800-341-7400
SCHWAB MARKETMANAGER INTL. 14.2 9.3 800-435-4000
MSDW FUND OF FUNDS INTL. C 14.2 2 0.9 800-869-6397
WM STRATEGIC GROWTH A 14.0 21.4 800-222-5852
KOBREN GROWTH 12.0 12.2 800-895-9936
WM CONSERVATIVE GROWTH A 11.6 18.0 800-222-5852
SOURCE: MORNINGSTAR INC. AS OF 6/11/99 WHITNEY DODDS WOODRUFF - STAFFV