A ‘Fund Of Funds’ (FOF) is an investment strategy of holding a portfolio of other investments in mutual funds rather than investing directly in stocks, bonds or other securities. An FOF scheme primarily invests in the units of multiple mutual fund schemes. This type of investing is often referred to as multi-manager investment or multi asset investment or multi diversified strategy allocation.
These mutual fund schemes offer the investor an opportunity to diversify risk by spreading investments across multiple mutual funds each has a different perspective of the market. The underlying investments for a Fund of Fund (FoF) are the units of other mutual fund schemes either from the same mutual fund house or multiple mutual fund houses.
Next we will review the various types of FOF Mutual funds. Asset allocation mutual funds consist of a diverse asset pool in multi asset class securities comprising equity mutual funds, debt mutual funds, precious metals mutual funds, etc. This allows asset allocation mutual funds to generate high returns through the best performing asset class allocation model, while reducing the risk present in an overall fund portfolio.
This is another type of multi manager Fund of funds mutual funds available in the Indian mutual fund market. The asset base of such a fund comprises various professionally managed mutual funds, all of which have a different portfolio concentration and themes. A multi-manager fund of funds usually has multiple experienced portfolio managers, each dealing with a specific asset present in the mutual fund.
Gold mutual funds are commonly referred to as commodity mutual funds, and the ones that invest in gold securities, are referred to as Gold mutual funds. Gold Fund of funds belonging to this category can have a portfolio of gold mutual funds or gold trading companies, gold miners etc. depending upon the asset management concentration and overall macro trend. These mutual funds historically provide higher returns during times of market stress.
Mutual funds operating in foreign countries come under the international Fund of funds. This allows domestic Indian investors to obtain higher returns through the best-performing stocks and bonds of the respective country. These mutual funds also provide multiple currency exposure if they are un-hedged.
ETFs Fund of funds consist of low cost exchange traded funds in a portfolio and is a popular investment tool in India. Investing in an ETF fund of funds is more accessible than a direct investment in this instrument. It is important to note that ETFs have a higher risk factor associated with them as they are traded like shares in the stock market, making these Fund of funds more susceptible to the volatility of the market as well as liquidity risks.
Fund of funds are also managed by highly skilled managers with decades of investing experience. Proper trading, macro market analysis made by such portfolio managers may ensure high returns through multiple fund investment strategies.
Diversification is commonly known as the Holy Grail of investing. Fund of funds target multiple best performing mutual funds in various markets, each specialising in a particular asset or sector fund. This ensures gains through multi asset diversification, as both risks and returns are optimised on account of the overall portfolio mixture. Even an investor who has a limited size financial portfolio can invest in the top fund of funds available and diversify returns, risks. Monthly investment schemes can also be availed while choosing a fund of funds investing styles.
An important point to note under current Income Tax regime in India as of 2021, a FOF is treated as a non-Equity mutual fund and consequently taxed accordingly. In other words, even though a FOF may be investing in equity oriented mutual funds, the FOF itself is not regarded as an equity oriented fund, and consequently, the tax benefits currently available to an equity fund are not available to a Fund of funds. As a result of which, in case of Fund of fund investing in equity securities of domestic companies via EOFs, there is DUAL levy of Dividend Distribution Tax (DDT), viz., when the domestic companies distribute dividends to their shareholders and again, when the FOF distributes the dividends to its unit-holders.
Expense ratios to manage a fund of funds(FOF) type of mutual fund are higher than the normal standard mutual funds, since it has a higher skill requirement. The added expenses include finding the right market and assets to invest in, whose allocation changes periodically. This expense amounts to a substantial amount, and therefore is deducted from the annual returns generated by the asset management company commonly called AMC for that mutual fund.
The information, analysis and opinions expressed herein are for education purposes only and are not intended to provide specific advice or recommendations. This material is not an offer, solicitation or recommendation to purchase any financial products or services. Always remember that all investments carry some level of risk, including the potential loss of principal invested.