The selection of a suitable portfolio of investments is a process that requires a great deal of thought. Most people have neither the time or investment knowledge to select and monitor a range of individual shares.

Open-Ended Investment Companies (OEICs) and Unit Trusts which employ a specialist manager to use investors’ capital in order to generate returns are therefore popular.

However a reliance on one particular fund manager is not particularly wise. Even the most skilled managers will underperform their benchmarks occasionally and the additional diversification offered by a fund of funds could be a possible solution.

It is difficult to choose a consistently strong performing fund manager. Whilst there are certain managers of high repute – for example Neil Woodford of Invesco Perpetual or John Chatfeild-Roberts of Jupiter – no manager is infallible. People should also be wary of placing too much emphasis on the past performance of any given manager.

Statistics from ‘Which?’ reinforce this idea. Actively managed funds are those that employ a specialist manager to look after the investors’ money.

According to research from the consumer advisor, just 38 per cent of active funds were able to outperform the FTSE All Share Index over the past ten years. The vast majority of managers in this sector are therefore failing to justify their charges.

A possible solution might be for investors to place their money into passively managed funds. These aim to emulate the performance of the index to which they are linked. The problem is that after the deduction of charges, such funds will always underperform their index.

Another alternative is the multi-manager fund of funds approach. These are investment funds that invest in a range of other funds controlled by different managers, as opposed to selecting assets on an individual basis.

The main effect of this is to add an extra layer of diversification through the holding of funds that already contain a variety of stocks. In this way some fund of funds will incorporate the skills of up to twenty fund managers.

The fund of funds itself will be managed by a specialist team. This team will use both quantitative and qualitative analysis in order to identify the fund managers that they expect to deliver the best returns.

All necessary decisions with regards to asset allocation will be made in a manner that ensures that the fund as a whole remains appropriate to the investor’s attitude to risk.

According to statistics from the Investment Management Association the total amount invested in fund of funds has risen by 18 per cent in the last 12 months. Fund of funds now account for over 10 per cent of private investors’ funds under management.

However, care should be taken in choosing the most appropriate fund of funds. The decision should be taken in accordance with an investor’s individual circumstances and attitude to investment risk.

It would also be wrong to assume that the additional layers of diversification, characteristic of fund of funds, are a guarantee of market beating returns.

Research from trustnet has highlighted a failure of some fund of funds to achieve an acceptable level of returns for investors. For example within the IMA Flexible Investment Sector, on average fund of funds have returned 21.36 per cent over the past five years compared to 26.9 per cent from a conventional stocks and shares fund.

A possible reason for this is that some fund of fund managers are placing too much emphasis on short-term returns. This has led to frequent changes in asset allocation, volatility and therefore underperformance.

A properly run fund of funds can have a variety of benefits for investors, and a financial adviser can aid in the selection of a fund that will invest in line with your individual attitude to investment risk.

In addition to the previously mentioned expertise of the fund managers and diversification benefits, there are also tax advantages. Their structure means that the fund manager is able to make fund switches without incurring any personal CGT liability for the investor at the time.

The fund managers are also in a position to negotiate bulk buying discounts meaning that the cost of investment is less than if you were to purchase shares on an individual basis. Investors will also be able to invest in areas that would ordinarily only be accessible to individuals with very large sums to invest.

The main criticism of fund of funds is directed towards the fact that they carry a higher level of charges compared to conventional OEICs and Unit Trusts.

This is essentially because the investor is employing the services of two levels of management – the team in charge of the fund of funds and the fund managers within.

However a fund of funds that is well managed and aims to achieve long-term returns for its investors, should be able to justify these charges.

* Trevor Law is a director with Merito Financial Services, chartered financial planners, based in Solihull. E-mail: tilaw@meritofs.com