A Fund of Funds (FoF) is a confusing name for any mutual fund type. But the name makes sense because this particular fund puts money in other mutual funds – debt, equity, gold or even international or a combination of these. Simply put, when you choose a fund of funds, you possess a single fund that holds other funds in it.
There are umpteen types of fund of funds, with each investing in a different kind of combined investment scheme. Typically, investors keep the investment-FOF ratio 1:1. They like to invest in regular mutual funds and FOFs simultaneously as the treatment for both regular MFs and FOFs are almost similar, but the latter allows them to diversify their portfolio further.
Designed on the principle of ‘lose less’, it puts money in multiple fund category and comes with minimal risks. Hence you get maximum out of single but diverse investment plan. Examples for fund of funds – Hedge funds (FoF), Mutual fund (FoF), Private equity (FoF) and Investment trust (FoF)
A glimpse into the 4 sought-after funds of funds in India
Gold funds: By typically investing in gold exchange-traded funds, gold funds make it easier for investors who do not hold a demat account unlike a direct gold-ETF investment. Gold FoFs also offer SIP investment options. SBI Gold Fund, Kotak Fund and Axis Fund are some of the most popular examples for this type of fund of funds.
Asset allocation funds: A little of your money across various schemes from diverse asset classes – asset allocation funds manage diversification and risk minimization like no other fund. One can either invest dynamically in debt or equity funds after careful market study or invest aggressively in a combination of the two.
Multi-manager fund of funds: Most funds of funds invest with their own asset management companies or fund houses. But multi-manager FoFs invest in schemes offered by other fund houses too.
Foreign or international fund of funds: Not every domestic fund will possess the capital or insight to follow overseas market trends. This is why some of the more adventurous investors pick international funds. They make a perfect roadmap for more Indian investors to capitalize on themed equity funds abroad. You can invest and redeem in INR too.
Benefits of fund of funds
Diversification in one go: Fund of funds are designed for investors looking for a diversified investment (and hence with minimal risks) plan.
Convenience: You get to hold multiple kinds of funds with a single investment, whether it is asset-allocated or dynamically-managed as mentioned above.
Fund availability: As these schemes are mostly open-ended, there are no restrictions on the transactional timelines and the number of shares/units one can buy/sell.
No entry load: An investor can pick up a share at the face value of Rs. 10 per unit, as these FoF schemes don’t impose any entry load.
Premature withdrawal: You have the option to exit prematurely – they will levy a nominal exit load based on the current NAV.
Liquidity: You can avail purchases and unit redemptions on all business days at NAV based prices. You only need to wait for five business days from the date of allotment of units under the scheme.
Exposure: You get exposure to a slew of funds. For instance, you do not need to open a demat account to invest in a gold-ETF.
Greater gains: Fund companies typically invest in a small range of securities and control them directly. FoF strategy enables investors to be a part of a collective and diverse investment scheme and reap greater gains.
Reduced efforts: FoF reduces the investment efforts that investors put out to select suitable fund schemes for their portfolio. Leave it all to the fund house.
Start small: Go for SIP to counter market volatility. The minimum investment is only Rs. 500. FoF schemes offer both the dividend and growth option. If you opt for the dividend option, you can use the payout for reinvestment.
Less risks: An FoF will not dip as much as the worst performing fund within it. Hence, it is favored for its risk adjusting characteristic and better returns.
Dividends: The mutual fund company deducts dividend distribution tax and pays a dividend to the investor.
Disadvantages of fund of funds
- When it comes to tax-efficiency, fund of funds gets the same treatment as debt funds. This means, it doesn’t get the same tax benefits as equity funds even with equity exposure.
- Short-term capital gains are taxed as per the tax slab and long-term capital gains are taxed at 10% without Indexation and 20% with Indexation.
- As majority of fund of funds take equity exposure to their own asset management company, it will not provide you with diverse fund house styles. You won’t even get to select the best in each.
- Income Tax of 10% must be paid if the dividend is greater than Rs. 10 lakhs.
- FoF Management Fees include the fees charged by the underlying funds and hence it will be higher than other funds.
- Too Much Diversification is a possibility as an FoF might invest in hundreds of funds at a time.
- As mentioned above, a single FoF buys several different funds, which they again invest in other stocks, which makes some FoFs difficult to track.
Despite its high investment fees, Funds of Funds is great for medium-to-long-term investment. Do take care to go through the fine print before putting your signature at the end. Stick to well-known funds that hold good reputations for fiscal strength, at least in the beginning. Focus on maintaining a long-term horizon to beat inflation and get better returns.