Editor's note: This is the second of four columns in which Vern Hayden discusses current investment fads. Last week, he looked at funds with multiple star managers. Today, he examines funds of funds. Still to come: classic asset allocation and timing strategies.

When I was a kid, some nut stretched a high wire over Niagara Falls and walked across it. He made it, but one slip and it would have been all over.

Michael Hirsch

considers anyone fully invested in a single growth equity mutual fund to be in the same category as the tightrope walker.

Hirsch is the father of the fund-of-funds concept. A fund of funds is simply a mutual fund that invests in other mutual funds instead of individual stocks. You get instant diversification with the purchase of a single fund.

But his investment philosophy goes beyond that. In choosing funds, Hirsch and his followers seek to limit losses rather than maximize gains. It's not a strategy that's real popular in today's bull market. Hirsch's

FundManager

series funds tend to perform below average in up markets. But, in theory, they are above average in flat markets and superior in down markets. Though, as we shall see, that's not always the case.

Here are some other principles Hirsch and others are using in the fund-of-funds concept:

  • Instead of looking for the fund that will double over the next two years, search for the fund that will go down in value only half as much as the overall market during a decline.
  • Be aware of the risk of investing in a single asset class, such as stocks or bonds. In the spring of 1987, bonds plunged 20% to 30%. And from Oct. 12 though Oct. 19 of the same year, the stock market fell 30%. If you had all of your money in either asset class, you would have suffered a significant loss.
  • Diversification should include funds that invest in large, medium and small companies with a mix of value and growth managers.
  • The focus of fund-of-funds managers always should be on avoiding loss. When you invest, you will experience losses at some point. The larger the losses, the more difficult it will be to overcome them. It is important to cushion losses and have more consistent returns.

To give you an idea of what's inside a fund of funds, let's look at Hirsch's

(FTGFX) - Get Report

FundManager Growth fund. As of Sept. 30, 1998, 72% of the fund was invested in these five funds:

(VIGRX) - Get Report

Vanguard Growth Index,

(VIVAX) - Get Report

Vanguard Value Index,

(NYVTX) - Get Report

Davis New York Venture,

(YACKX) - Get Report

Yacktman and

(GPAFX) - Get Report

Guardian Park Avenue.

With all this said, how have they done?

First, let's see how three of Hirsch's FundManager equity funds (which he managed until last month) have done over the past five and 10 years, compared with the

S&P 500

.

Hirsch and followers believe it is important to look at year-by-year returns, not just cumulative returns. In a race between the hare and the tortoise, the tortoise fund almost never delivers over the short term. But, as you can see, over five- and 10-year periods, Hirsch's equity funds of funds lag the S&P, though their year-by-year returns may have been less volatile than those of the hare funds.

Since the tortoise fund is supposed to make money by not losing as much in down markets, let's see how Hirsch's funds did in the down years of 1987, 1990 and 1994.

Again, the funds' premise seems to work better in theory than in practice.

The results seem to show that it is one thing to have a conservative investment philosophy and an entirely different thing to be able to implement it. In fairness, when these results are compared with other benchmarks, such as the

Russell 2000

small stock index and other funds in the various categories, they look better. As most of you know, for a number of years, the S&P 500 has put the tortoise approach out of the race. But you can be sure there will be a time when the tortoise will be back.

As an investment adviser, I don't use funds of funds. I prefer the flexibility of being able to allocate assets according to a client's specific needs. If you don't have the time or inclination to assemble a diversified portfolio on your own, a fund of funds is one way to do it. But if you are willing to do some active managing of your own, you probably can do better.

Vern Hayden is a certified financial planner with the American Planning Group in Westport, Conn. His column is not a recommendation to buy or sell stocks or to solicit transactions or clients. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. Hayden welcomes your feedback.