An Underlying Fund is an investment fund in which another fund invests, typically part of a fund-of-funds structure, representing the primary assets backing the investing fund.
An Underlying Fund refers to an investment vehicle that serves as the actual investment destination within a fund-of-funds or similar multi-layered investment structure. Instead of directly holding securities or assets, the primary fund allocates capital to one or several underlying funds that manage their own portfolios. These underlying funds operate independently with their own strategies and portfolios, while the investing or feeder fund reflects their performance to its investors. This structure allows for diversification and access to specialized management strategies across different asset classes or investment styles.
Understanding the role of an Underlying Fund is crucial for investment strategy and risk management, particularly when utilizing fund-of-funds structures. It influences due diligence processes, fee transparency, exposure analysis, and tax considerations. Since fees can be layered in such structures—the investing fund incurring its own fees plus those of the underlying funds—it is important to monitor and manage overall cost efficiency. Additionally, accurate reporting and performance attribution require clear visibility into underlying fund holdings and activity, which aids governance and compliance within complex family office portfolios.
Consider a family office investing $1 million into a fund-of-funds. This fund allocates its capital across five underlying funds, each specializing in different asset classes such as private equity, real estate, and hedge funds. The performance the family office sees is directly linked to the combined returns of these underlying funds, minus the fees charged at both levels. If one underlying fund returns 8% and others vary, the overall return is a weighted average of these results, reflecting the underlying fund exposures.
Fund of Funds
A Fund of Funds is a pooled investment vehicle that holds positions in multiple underlying funds rather than directly investing in individual securities. It helps investors achieve diversified exposure through a single investment but involves considerations related to layered fees and due diligence on all underlying funds.
What distinguishes an Underlying Fund from the investing fund?
The Underlying Fund is the actual investment fund where assets are directly managed, whereas the investing fund allocates capital to one or more underlying funds and passes their performance to its investors but does not manage assets directly.
How do fees work with Underlying Funds?
Fees can be charged at both the investing fund level and the underlying fund level, potentially resulting in a layered fee structure that impacts net returns. It is essential to carefully review fee disclosures to understand total costs.
Are there additional risks with investing through Underlying Funds?
Investing via Underlying Funds adds complexity in terms of transparency, liquidity, and due diligence since exposure is indirect. Investors need to assess the risks of each underlying fund as part of the overall portfolio risk management.
