1. What is Fund of Funds?
A Fund of fund is a mutual fund scheme that invests in other mutual fund schemes. In this, the fund manager holds a portfolio of other mutual funds instead of directly investing in equities or bonds. The fund may choose to invest in a scheme of the same fund house or some other fund house. The portfolio is designed to suit investors across risk profiles and financial goals. The investors get an opportunity to benefit from the diversification as a result of investing in numerous fund categories.
Fund of funds can be domestic as well as overseas. In case of foreign fund of funds, the fund manager invests in units of overseas mutual fund schemes. He/she ensures that the target fund’s investment philosophy and risk profile matches with that of the fund’s mandate. The main objective is to create wealth over the long run.
2. Who should invest in Fund of Funds?
Fund of funds is a good bet for small investors who do not wish to take too much risk. The diversification of funds helps with reducing the risks to a certain extent. This is also a great medium of investment for an investor with small amounts of funds available for investment each month. In addition to this, investors who have an investment horizon of five years or more may think of investing in this fund. You will get the benefit of professional fund management.
3. Most sought-after Fund of Funds in India
Of the many fund of funds available in India, the four most sought-after FoFs include:
a. Asset Allocation Funds
Asset allocation funds are mutual funds that invest in a varied class of assets. These assets range from equity-oriented, debt-oriented or even other asset classes like gold, other metals, and commodities. Visit ClearTax for more information on Asset Allocation Investment Options.
b. Gold Funds
These funds invest in various forms of gold, be it in the form of physical gold or in the form of stocks of gold mining companies.
c. Foreign or International Fund of Funds
International funds are investments in mutual funds comprising bonds and shares of global companies.
d. Multi-manager Fund of Funds
A multi-manager fund is one that consists of many professionally managed funds but is a single portfolio.
4. Things to consider as an investor
Fund of funds relies on the principle of deriving the maximum benefit out of single but diversified investment plans. As an informed investor, you must weigh the pros and cons of this scheme before making any investment decision. Select an experienced fund manager and know your risk tolerance, transactional timelines, tax implications, etc. Listed below are some of the benefits and drawbacks of investing in fund of funds that one should be mindful of.
5. Advantages of Investing in Fund of Funds
If you wish to rebalance your assets, there will be no tax on capital gains for this internal transaction. Therefore, when your fund of funds are rebalanced to maintain a said allocation between debt and equity, there will be no tax on capital gains.
b. Ease of Handling
There is just one NAV to track and only one folio. This makes it easy to handle the reduced number of funds that require managing.
c. Professional Fund Management Services
Investing in fund of funds allows you to try out investing in professionally managed funds before they can venture out on investing individually.
d. The Credibility of Portfolio Managers
As fund of funds requires the backgrounds of its managers to be checked and verified, you can be assured that a credible person handles your funds.
e. Opportunity for investors with limited capital
Fund of funds allows investors who possess only limited wealth to partake in diversified that have underlying assets. These assets would otherwise be hard for such investors to access individually.
6. Disadvantages of Investing in Fund of Funds
a. High Expense Ratio
Fund of funds incurs expenses just like any other mutual fund schemes. But unlike mutual funds, there is extra cost involved. Apart from the general management and administrative fees, there is an added expense about the underlying funds. Despite the FoF expense ratio being just 1%, as an investor, you will still pay this amount on every fund that the FoF owns.
b. Tax implications
Short-term capital gain tax according to the income tax slab of the investor would be applicable if sold before 36 months. If the units are sold after 36 months, a long-term capital gain tax of 20% with indexation is levied.
c. Too much diversification
Fund of funds invests in many funds which further invest in several securities. This gives rise to the possibility of the fund of funds, ending up owning the same stocks and securities through different funds. This reduces the potential for diversification.
7. Top 5 Fund of Funds in India
Listed below are some of the top picks from the fund of funds available in India, based on the past three years returns. Investors may choose the funds based on a different investment horizon as well, like, five years or ten years returns. You may also include other criteria like financial ratios, etc.
Fund of Funds
|1 year||3 year||5 year|
|Aditya Birla Sun Life Global Commodities Fund||16.58||3.19||2.35|
|Kotak Gold Fund-Regular Plan||7.41||3.52||1.59|
|SBI Gold Fund||7.1||3.59||1.58|
|HDFC Gold Fund||6.58||3.65||1.82|
|Axis Gold Fund||5.79||1.89||0.09|
Note: Rankings are based on returns calculated on NAV as on 29 August 2019. The order of funds is not indicative of any recommendations on the part of ClearTax. Investors may choose the funds as per their goals. Returns are subject to change.
Fund of funds can be the right investment choice for an investor with limited experience and limited funds. Fund of funds like mutual funds are subject to market risk and therefore mandate the investor acquaint him/herself with the market risks and the strategies of investment.
Not sure if fund of funds is the right fit for you? Visit ClearTax for the option of choosing from a mix of hand-picked funds tailored to meet your investing needs.