Key Takeaways:
- A Fund of Funds (FoF) invests in a portfolio of other mutual funds, not directly in stocks or bonds.
- Offers easy diversification across asset classes, geographies, and fund managers.
- Compared to regular mutual funds, FoFs provide broader exposure but come with double-layered expense ratios.
- Suitable for investors seeking a simplified and well-diversified investment approach.
- Advantages include professional management, risk spreading, and convenience.
- Disadvantages include higher costs, possible tax inefficiencies, and limited control over individual fund holdings.
Imagine you want to make a playlist, but what if instead of selecting each song one by one, you get a playlist already made by someone including all the songs you like. Sounds easy?
That’s exactly what Fund of Funds is.
Fund of funds allows you to invest in various mutual funds instead of just investing in individual stocks or bonds.
If you have ever wondered how to invest across multiple mutual funds without managing each one separately, then this guide is for you.
Let us understand the concept of Fund of Funds in this blog –
What is a Fund of Funds?
A Fund of Funds or FoF, is like a mutual fund that invests in other mutual funds instead of directly investing in stocks, bonds, or other assets.
Instead of buying individual mutual funds on your own, you can invest in a single FoF that allocates your money across various funds based on its goal. The idea is to make your portfolio more diversified and professionally managed.
Fund of Funds vs. Other Mutual Funds
You must be wondering what the difference is between a fund of funds vs. other mutual funds. Think of it like this, when you are shopping online, you often visit different websites for different needs, one for clothes, another for gadgets and a separate one for home decor.
Similarly in other mutual funds, you have to invest and manage individual stocks and bonds separately.
Now imagine having one platform that brings everything together – like Amazon, where you get fashion, electronics, home items and more in one place. That is what a Fund of Funds does for your investments. You can invest in a single FoF that allocates your money across various funds based on its goal.
Types of Fund of Funds
There is not just one type of Fof. They come in different types depending on their investment strategy:
1. Multi-Manager Fund of Funds
Multi-Manager Fund of Funds is a type of FoF that invests in mutual funds that are managed by various mutual fund managers or Asset Management Companies (AMCs). Instead of depending on one fund manager or AMC, it is crucial to spread your money across various managers, each with different levels of expertise, strategies and market insights.
2. Asset Allocation Fund of Funds
In simple terms , Asset Allocation Fund of Funds is nothing but allocating your money among equity funds, debt funds and even gold or international funds. Investors adopt this strategy because it reduces the risk and increases the chances of earnings.
3. International Fund of Funds
Want to invest globally? These FoFs invest in international mutual funds or ETFs. Thus it allows Indian investors to get exposure to global markets like the US, Europe, China, etc., without directly investing abroad.
4. ETF Fund of Funds
ETF Fund of Funds are like mutual funds but traded on the stock exchange exactly like shares. Now imagine that you do not have to pick individual ETFs by yourself, rather you invest in one single fund that does everything for you. This type of FoF is low in cost and a diversified option.
5. Gold Fund of Funds
Gold Fund of Funds invest in mutual funds or ETFs that hold gold as an asset. If you want to invest in gold-related assets but don’t want to buy it physically, these FoFs are a practical alternative.
Advantages of Fund of Funds
| Diversification | FoFs provide instant diversification. Since they invest across multiple mutual funds, it spreads your risk and thus if one fund underperforms, it reduces the impact of it. |
| Risk Mitigation | Risk mitigation is the process of planning strategies in order to reduce the risk. FoFs help in balancing risks by combining various asset classes, sectors, and fund managers. This makes them a good option for new investors. |
Disadvantages of Fund of Funds
| Higher Expense Ratio | Since you are investing in a fund that invests in other funds, you may end up paying two layers of fees – one for the FoF itself and another for the underlying mutual funds. This can reduce your returns. |
| Tax Liabilities | Taxation of FoFs in India is not always favourable. Even if they invest in equity funds it is not taxed like equity funds instead most FoFs are taxed like debt funds. This means: 1. Short-term capital gains (if held less than 3 years) are taxed as per your income slab. 2. Long-term capital gains (if held more than 3 years) are taxed at 20% with indexation. |
The Bottom Line
A Fund of Funds can be a smart way to gain access to a diversified and professionally managed portfolio without actively managing multiple funds yourself. These funds are ideal for new investors who want to seek global exposure or those who just want a simple asset allocation strategy.
However, it is important to note its higher costs and tax implications involved. One should always check what the FoF is investing in and whether it aligns with their financial goals.
If you want an investment with built-in diversification and don’t mind slightly higher fees, a well chosen FoF can be a valuable addition to your portfolio.
Frequently Asked Questions
Are Fund of Funds safe during a market crash?
FoFs are not immune to market crashes, especially if they invest heavily in equity-oriented funds. However, those that are well-diversified or include debt and gold can help reduce the impact of market volatility.
How are Fund of Funds taxed in India?
Most FoFs are taxed like debt mutual funds, even if they invest in equity funds. Short-term gains (under 3 years) are taxed as per your income tax slab, while long-term gains are taxed at 20% with indexation benefits.
Are Fund of Funds good for long-term investment?
Yes, if you choose the right type (e.g., asset allocation or international FoFs), they can be suitable for long-term goals. Their diversification and professional management make them a convenient option for long-term investors.
