THE rollercoaster ride many stock market investors have endured in recent years has left them grasping for steadier alternatives. While managed funds are popular, funds of funds and multimanager funds offer additional alternatives to those wanting to diversify further.

Funds of funds invest in a wide selection of managed funds rather than directly into stocks. Multimanager funds bring in outside experts to run different parts of a fund, such as American or Asian equities. Despite their differences, both types tend to be referred to interchangeably.

“A traditional fund manager oversees all areas of a fund but, of course, nobody can be an expert in all areas,” said Dara Fitzgerald, the marketing and business development director at Focus Investments.

Most seasoned players will tell you that the secret for long-term success in the investment game is diversification, and these funds fit that bill.

“With funds of funds and multimanager funds, your risk is spread,” said Fitzgerald. “These funds can tap into knowledge and expertise in various parts of the world and act quickly when a fund or manager has gone off the boil.”

Fund of fund managers go through a rigorous process of selecting funds, says Kevin Kirwan, an investment manager with Financial Engineering Network, authorised advisers. “They are constantly monitoring individual funds,” he said. “Overall risks are reduced in so far as where one fund may have a weak performance, it is only a part of what you invest in.”

Growth in these areas has been pronounced over the past few years, and is a result of frustration about the underperformance of many single, active managers, according to Tom Geraghty, a senior investment consultant with Mercer Investment Consulting.

“The larger funds with billions of euros of assets under management have been moving increasingly from single, active, balanced structures to structures where specialists are brought in to manage different areas,” Geraghty said. “That is not an option for smaller funds, but a fund of €5m-€10m can have access to this type of expertise by buying units in other funds.”

One area that has grabbed headlines in recent years is funds of hedge funds, in which aggressive strategies, such as short selling, leverage and derivatives, are the norm.

“Hedge funds of funds are generally pitched at larger and more sophisticated investors,” said Fitzgerald. For that reason, Ifsra, the financial regulator, stipulates minimum investments in them. Some have an entry level of €250,000.

There are other ways, however, to invest in multimanager funds. Many financial institutions have linked up with external experts to manage their portfolios. Eagle Star, for example, has teamed up with Frank Russell, a leading American multi-manager specialist; KBC has joined forces with Northern Trust; and Wilshire is in charge of Standard Life’s multimanager funds, says Geraghty.

The price of gaining such expertise can be higher fees. “There may be an additional layer of costs involved, with the underlying manager charging a fee on top of the fund managers’ fee,” said Fitzgerald. It pays, therefore, to compare firms’ pricing structures.

Davy, for instance, offers multimanager funds geared towards retail investors, where Frank Russell picks the underlying managers, according to Michelle O’Keefe, a director of Davy’s private client service.

“The minimum investment is €6,500, with a 2% upfront charge,” said O’Keefe. “The annual management fee is 1.35% and this covers Russell’s management. There are no exit charges and no fees for switching from one fund to another.”

The exit tax rate applied to gains from investing in these types of funds is 23%.

Standard Life has just launched its first range of lump-sum or single-premium multimanager funds. Managed by Wilshire, the minimum investment is €10,000, with annual fees of 1.35%-1.8%. There is no entry fee, but if an investor leaves within the first six years, a declining exit penalty, from 5% to 1%, is levied.

Fitzgerald warns that the benefit of these funds can be lost if those running the show scrimp on research. “There are thousands of funds and managers out there. Those doing the picking have put their resources into this process.” O’Keefe notes that one of the reasons Davy hooked up with Frank Russell is because the US giant spends €20m a year on research and meeting fund managers.

Another disadvantage could be overdiversification. “If you have a product with 15-40 underlying investment managers who are specialised in different parts of the market, you may end up getting only a broad market return,” said Geraghty. It is important to seek out funds that have not invested in too many others and which do not have too many underlying managers. Otherwise, buying into a passive fund that simply tracks the overall market may be a better proposition.