These Funds of Funds Are Worth a Look

It takes a certain degree of faith to invest in a fund of funds. Unlike owning a conventional mutual fund--in which a fund manager hand-picks securities or tracks those included in an index--owning a fund of funds calls for trusting in a manager who will oversee a portfolio made up of funds run by other managers (or index funds). For some investors, betting on one person to properly manage a group of funds run by other managers may introduce too much potential for error. After all, even if many of the fund of funds' underlying holdings are index funds, or active funds that do well, an over-allocation to laggards could lead to overall underperformance.

But for investors looking for an easy-to-own, well-diversified core holding, a fund of funds can be an attractive option. The growing popularity of target-date funds--many of which use a fund-of-funds structure with a changing allocation designed for retirement savers--suggests that investors are becoming more comfortable with such all-in-one investment vehicles (even if some have simply been auto-enrolled into such funds through their employer's retirement plan). 

But not all funds of funds serve the same purpose. Some are allocation funds, investing primarily in stock funds and bond funds, while others use the fund-of-funds structure to provide diversification with an asset class--such as multisector bond funds.

So what makes for a good fund of funds? One of the most important elements is a strong parent company offering strong funds. After all, funds of funds typically stay in-house with their portfolio holdings, and they can't perform well if their ingredients are subpar. Look for funds of funds whose underlying holdings include funds run by good managers. Another key feature is reasonable fees. Some fund companies layer on extra fees on top of what is charged by the underlying funds. A small added fee may be acceptable to help cover the fund of funds' own operating costs, but excessive added fees are unacceptable. Finally, a consistent, well-defined strategy is a must. A fund of funds may use a tactical allocation that shifts between or within asset classes based on market conditions, or it may maintain a fixed allocation regardless of conditions. Whatever the fund's approach, make sure it is clearly spelled out and executed consistently.

To search for quality funds of funds vetted by Morningstar's team of fund analysts, we turned to the  Premium Fund Screener. We left out target-date funds in search of funds of funds that make good core holdings in any account type, not just for retirement. Only funds with a Morningstar Analyst Rating of Bronze or better were considered, and we screened out institutional funds and those currently closed to new investors. Premium Members can see the full list  here. It includes the funds that follow.

 Fidelity Four-in-One Index (FFNOX)
Analyst Rating: Silver | Category: Aggressive Allocation | Expense ratio: 0.22%
This fund's portfolio is made up of four index-based funds--two domestic equity-based funds that cover the full market-cap spectrum in the United States, one that covers international developed markets, and a domestic fixed-income fund. The result is a well-diversified portfolio of more than 4,000 stocks and 1,000 bonds with a target allocation of 85% equities--about 5 points higher than its typical aggressive-allocation peer's, says Morningstar senior fund analyst Janet Yang. In rising equity markets, the larger-than-average helping of stocks means the fund should perform well. In exchange, however, investors should expect less protection when markets falter. In the last 10 years, for example, the fund outpaced its typical peer in almost 80% of up markets but only 35% of down markets. Meanwhile, the fund's rock-bottom fees provide a built-in advantage. Yang notes that investors could skip this fund's 0.08% oversight fee (above what its underlying holdings charge) by assembling the four underlying funds on their own, though this would require investors to rebalance on their own as well.

 T. Rowe Price Spectrum Income (RPSIX) (
)Analyst Rating: Silver | Category: Multisector Bond | Expense ratio: 0.69%
This fund allocates tactically to nine T. Rowe Price mutual funds--seven of which are Morningstar Medalists--investing in various asset classes and sectors including high-yield, international, and agency bonds, as well as a sizable allocation to dividend-paying equities. An equal allocation to each fund provides a jumping-off point, and the firm's 12-member asset-allocation group determines how much to stray from those allocations. This fund tends to outperform its typical peer when risky fixed-income assets take a beating, but it lags when credit sectors rally. This is mostly because of its smaller stake in high-yield bonds, says senior fund analyst Cara Esser. The fund imposes no additional management fees on top of what it pays its underlying strategies.

 Vanguard LifeStrategy Income (VASIX) 
Analyst Rating: Gold | Category: Conservative Allocation | Expense ratio: 0.14%
Conservative-minded investors will be well-served by this fund, says fund analyst Kathryn Spica. It maintains a consistent allocation of 20% in stocks and 80% in bonds, weightings that are slightly more bond-heavy than the fund's typical conservative-allocation peer's 35%/65% stock/bond allocation. The fund is built around a portfolio of four core index funds--a total U.S. stock market fund, a total international stock fund, a total U.S. bond fund, and a total international-bond fund. By forgoing tactical asset-allocation shifts, the portfolio's results are not prone to timing missteps, letting its overall asset allocation drive results. Vanguard doesn't tack an additional layer of fees onto its funds of funds, keeping expenses limited to just the costs of its underlying funds.