Fund of Funds (FoF)

Fund of Funds are mutual fund schemes that invest in other mutual funds instead of investing directly in stocks, bonds, or other securities. These funds provide investors with built-in diversification.

What are Fund of Funds?

Fund of Funds are structured to allocate investor money across a portfolio of existing mutual fund schemes, whether domestic, international, or a combination of both. Instead of directly investing in securities, they invest in other professionally managed funds, thereby allowing investors indirect exposure to a range of strategies.

For example, an international FoF in India might invest in a US-based global equity fund. Likewise, a multi-asset FoF may allocate funds into equity, debt, and gold schemes under the same or different AMCs like ICICI Prudential Multi-Asset Fund and HDFC Multi-Asset Fund.

How Do Fund of Funds Work?

The fund manager of a FoF selects and monitors a mix of underlying mutual funds, aiming to optimise returns while managing risk. The underlying funds may belong to the same or different AMC schemes. The returns of a FoF depend on the collective performance of its holdings and may vary based on asset allocation, market cycles, and fund choices.

FoFs can be either active or passive strategies. Passive FoFs typically track indices via ETFs, while active FoFs involve tactical allocation and fund selection by the manager.

Types of Fund of Funds

Fund of Funds come in various forms, each tailored to meet different investor goals and risk appetites.

Asset Allocation FoFs

Invest across multiple asset classes such as equity, debt, and commodities like gold. These funds dynamically adjust their portfolio mix to maintain a balance between risk and reward over time.

International FoFs

Offer exposure to foreign equity or debt markets through investments in global mutual funds. These allow Indian investors to access opportunities in developed or emerging markets without opening a foreign trading account.

ETF-based FoFs

Allocate funds into Exchange-Traded Funds to track indices or specific market segments. They provide low-cost, passive exposure to broader markets or specific sectors with minimal tracking error.

Target-Date FoFs

Structured for retirement or future goals with a dynamic allocation that becomes conservative over time. These funds automatically reduce equity exposure as the target date approaches to ensure a smoother glide path to the goal.

Features of Fund of Funds

Here are the defining characteristics that make FoFs a unique investment solution.

Diversification

Exposure to a broad range of funds minimises portfolio risk. It helps balance losses from underperforming funds with gains from better-performing ones.

Professional Management

Experienced fund managers handle fund selection and asset allocation. Their decisions are based on research, historical performance, and market dynamics.

Simplified Investing

Investors can access multi-strategy or global exposure via a single scheme. This eliminates the need for choosing multiple individual mutual funds.

Rebalancing Mechanism

Automatic adjustment of the underlying mix as per market changes or investment goals. This maintains the desired risk-return ratio throughout market cycles.

Benefits of Investing in FoFs

Fund of Funds offers convenience, exposure, and portfolio resilience in one package.

Ease of Diversification

Access multiple strategies or markets without researching individual funds. Ideal for investors who want broad exposure with minimal effort.

Global Opportunities

International FoFs allow seamless investment in global funds and economies. These help you participate in developed market trends and innovation stories.

Lower Entry Barriers

Gain exposure to diversified assets even with small investment amounts. FoFs make it possible to invest in high-quality global funds easily.

Goal-Oriented Options

Target-date or asset allocation FoFs are aligned with specific financial goals like retirement or children’s education. Asset mix is adjusted accordingly over time.

Risks and Limitations

FoFs carry some disadvantages that investors should keep in mind before investing.

Double Expense Ratio

Investors bear the expense ratio of both the FoF and the underlying funds, which may eat into returns. This can reduce net gains over time.

Taxation Drawback

Most FoFs are taxed like debt funds, even if they invest in equity-oriented funds. This affects tax efficiency for long-term investors.

Limited Control

Investors cannot select or modify underlying fund holdings. The investment strategy is entirely dependent on the fund manager’s decisions.

Over-Diversification

Excessive spreading across funds might dilute returns rather than improve risk-adjusted performance. This can lead to underwhelming gains in bullish markets.

Who Should Invest in Fund of Funds?

FoFs are ideal for a specific type of investor profile that values convenience and broad exposure.

Beginner Investors

Looking for a simplified way to invest across multiple strategies. Great for those who want exposure without deep research.

Passive Investors

Prefer not to manage or rebalance multiple schemes manually. FoFs help outsource fund selection to experts.

Global Exposure Seekers

Want international diversification without setting up foreign accounts. International FoFs simplify access to foreign markets.

Goal-Based Investors

Planning for milestones like retirement or children’s education with defined timelines. Target-date FoFs help automate asset allocation.

Fund of Funds vs Mutual Funds

A side-by-side comparison to understand how Fund of Funds differ from traditional mutual funds in structure, cost, and investor experience.

Popular Fund of Funds in India

A few popular fund of funds in India are as follows

Conclusion

Fund of Funds offers a powerful combination of diversification, professional oversight, and ease of access to both domestic and global investment opportunities. They are particularly useful for investors looking to simplify their mutual fund investments, gain exposure to international markets, or allocate across asset classes without active management.

However, it is important to weigh the cost implications and taxation aspects before investing. FoFs work best when aligned with long-term goals and when investors seek convenience over customisation. Like any other investment, evaluating your financial objectives, risk tolerance, and time horizon is crucial before allocating capital to a Fund of Funds.

Frequently Asked Questions (FAQs)

Are Fund of Funds suitable for beginners?

Yes, FoFs can be good for beginners who prefer diversified exposure without selecting individual funds. They simplify investing and reduce decision-making pressure significantly.

Why do Fund of Funds have higher expense ratios?

They charge their own fee in addition to the fees of underlying funds, resulting in a double-layered cost structure. This reduces net returns considerably.

How are Fund of Funds taxed?

Most FoFs are taxed like debt mutual funds in India, regardless of their underlying fund allocation. This makes them less tax-efficient over time. Long-term capital gains are taxed at 20% with indexation, which may reduce net returns. Always assess tax implications before investing.

Can I invest in international funds through FoFs?

Yes, international FoFs offer an easy route to invest in global markets without needing a foreign trading account. They’re ideal for global diversification. However, all investments carry market risks, and it’s essential to read all scheme documents carefully before investing.

Are FoFs better than investing in individual funds?

FoFs offer convenience and automatic diversification but come at a higher cost. They suit passive investors who seek hassle-free portfolio exposure. Always consider your financial goals and consult an advisor, as mutual fund investments are subject to market fluctuations.