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In the financial world, the term "umbrella fund" has two distinct definitions. In some situations, it refers to a type of retirement fund that pays pensions to employees who work for multiple companies. In others, it is a type of mutual fund that individuals may invest in which contains a variety of sub-funds. Each fund has its own characteristics and its own management team, and the overall structure of the fund allows investors to transfer their money easily between sub-funds.
A retirement umbrella fund is usually created by a group of small employers who do not have enough employees to create a large pension fund on their own. Each company takes payments into the pension fund from its employees. The companies then pool the funds together, placing them all under the control of a single pension fund manager. The manager invests the funds in one portfolio and generates returns. When the employees who paid in to the fund start to collect pension payments, they are all made from this pool of funds.
The advantage of the firms’ forming an umbrella fund rather than operating small pension funds individually is that pooling contributions allows the pension fund manager to make investments on a larger scale. Many financial markets have minimum investment limits that may make them inaccessible to smaller investors. Even if a smaller investment pool could have met the limits for a particular market, a larger investment pool can meet more of the limits simultaneously, allowing the pension fund manager to diversify the portfolio more. The increased flexibility of larger investment funds can help the manager create higher returns.
A mutual fund that is run as an umbrella fund, also called a fund of funds, is composed of several smaller funds, called sub-funds. These may be focused on different markets or have different investment strategies. Generally, each has a separate management team that supervises the investment of that sub-fund’s money. Investors in the umbrella fund choose how to distribute their shares across the different sub-funds.
An investor may choose to invest in an umbrella-style mutual fund if he wants increased flexibility in his investments with a minimum of transaction cost. He can instruct the fund to move his shares from one sub-fund to another instead of selling his shares in one fund and purchasing shares in another. This is convenient for the investor, and he can change his investment strategy while remaining with a management entity with which he is familiar. The disadvantage to this approach is that it can encourage investors to place too great a percentage of their investment portfolio under the control of one entity.