What do you do if you want to invest in mutual funds but aren’t sure which ones to pick?
You could spend hours researching, comparing returns, and tracking fund managers. Or, you could let an expert do all that for you by investing in a Fund of Funds (FoF).
In this post, we’ll break down what a Fund of Funds is, how it works, the types you’ll find in India, the pros and cons, and when it makes sense for you to consider investing in FoFs. Let’s dive in.
Estimated read time: 5 minutes and 21 seconds
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Buckle up. Here we go!
What is a Fund of Funds (FoF)?
A Fund of Funds, or FoF, is a special type of mutual fund that doesn’t invest directly in stocks, bonds, or other securities. Instead, it invests in other mutual funds.
Think of it as a “super fund” that holds a basket of other funds, giving you exposure to a wide range of investments through a single purchase.
In other words, when you invest in a FoF, your money is pooled with other investors’ money and then allocated across several underlying mutual funds. These could be from the same fund house or from different fund houses.
How Does a Fund of Funds Work?
When you invest in a regular mutual fund, your money goes into a pool that the fund manager uses to buy stocks, bonds, or other securities. But with a FoF, your money is invested in other mutual funds.
Here’s a simple example:
- You invest ₹10,000 in the ABC Fund of Funds
- The ABC FoF manager allocates this across multiple mutual funds:
- ₹3,000 in XYZ Large Cap Fund
- ₹3,000 in PQR Mid Cap Fund
- ₹2,000 in LMN Debt Fund
- ₹2,000 in GHI International Fund
The FoF manager continually monitors these underlying funds, making adjustments when necessary to maintain the fund’s investment objective, whether that’s growth, income, or balance.
So in one shot, your ₹10,000 is indirectly spread across dozens or even hundreds of global companies, without you needing to track or pick each fund or stock individually.
It’s diversification on autopilot.
Types of Fund of Funds in India
FoFs come in different flavours, depending on their investment strategy and the types of funds they invest in. Here are the most common types you’ll find in India:
1. Asset Allocator or Multi-Asset FoFs
These FoFs invest across different asset classes-like equity, debt, and gold-by picking mutual funds that focus on each category. The idea is to diversify your investments and reduce risk by not putting all your eggs in one basket.
2. International Fund of Funds
Want to invest in global markets? International FoFs invest in mutual funds that, in turn, invest in foreign companies. This gives you exposure to international stocks without the hassle of opening an overseas account.
3. ETF-Based FoFs
These invest in a basket of Exchange-Traded Funds (ETFs), which track specific indices like the Nifty 50 or Sensex. ETF FoFs are an easy way to get index exposure without needing a Demat account.
4. Gold Fund of Funds
If you want to invest in gold but don’t want to buy physical gold or open a Demat account for Gold ETFs, you can invest in a Gold FoF. These funds invest in gold ETFs, giving you paperless exposure to gold.
5. Thematic or Sectoral FoFs
These invest in a collection of mutual funds focused on specific themes, like technology, ESG (Environmental, Social, and Governance), or pharma.
Why Should You Consider Investing in a Fund of Funds?
Here are some of the major benefits of investing in FoFs:
1. Diversification
By investing in multiple funds across various asset classes and strategies, FoFs help spread your risk. If one fund underperforms, others may compensate, leading to a more stable overall return.
2. Professional Management
Choosing the right mutual funds requires time, knowledge, and continuous monitoring. FoF managers do this for you, using their expertise and resources to identify top-performing funds and fund managers.
3. Access to a Wide Range of Investments
FoFs can invest in funds that may not be easily accessible to individual investors-such as international funds or niche strategies.
4. Lower Investment Threshold
Some mutual funds have high minimum investment requirements. FoFs can give you exposure to these funds with a smaller investment amount.
5. Convenience
With a single investment, you get exposure to multiple funds, strategies, and asset classes. Instead of maintaining and tracking multiple mutual fund investments, you only need to monitor one FoF. This simplifies your investment process and paperwork.
The Not-So-Good Stuff: Disadvantages of Investing in Fund of Funds
Of course, no investment is perfect. Here are the key drawbacks of FoFs:
1. Higher Expense Ratio
This is the biggest drawback of FoFs. FoFs typically charge their own management fees, on top of the fees charged by the underlying mutual funds.
For example, if a FOF charges 0.5% and the weighted average expense ratio of its underlying funds is 1%, you’re effectively paying 1.5% in fees.
This “double-layer” of expenses can eat into your returns over time.
2. Over-Diversification
While diversification is good, too much of it can dilute the impact of high-performing funds. If you’re invested in too many funds, even the best performers may not make a big difference to your overall returns.
3. Performance Dependency
The success of a FoF depends on the performance of the underlying funds and the skill of the FoF manager in selecting them. If the chosen funds underperform, so will your FoF.
4. Lack of Control
You don’t get to pick the underlying funds or tweak the allocation. The FoF manager makes all decisions. If you disagree with their choices, your only option is to exit the FoF.
5. Tax Considerations
FoFs are taxed differently from regular equity or debt mutual funds. In India, any gains arising from FoFs will be considered long-term after 24 months, even if the underlying funds are equity-oriented.
Long-term capital gains from FoFs will be taxed at 12.5%, and short-term gains will be taxed at the investor’s income tax slab rate.
When Should You Consider Investing in a Fund of Funds?
1. You’re a Beginner Investor
If you’re new to investing and find the world of mutual funds overwhelming, a FoF can be a good starting point. It gives you exposure to multiple funds with a single investment decision.
2. You Don’t Have Time for Research
Managing a portfolio of individual mutual funds requires regular monitoring and rebalancing. If you’re short on time, a FoF can do this heavy lifting for you.
3. You Want International Exposure
International FoFs provide a convenient way to invest in global markets without dealing with currency conversion issues or opening foreign investment accounts.
4. You’re Looking for Niche Exposure
Some specialised FoFs give you access to niche markets or investment strategies that might be difficult to access directly.
5. You’re Building a Core-Satellite Portfolio
FoFs can serve as the stable “core” of your investment portfolio, providing broad market exposure while you use direct investments for tactical “satellite” positions.
Key Points to Remember Before Investing in a FoF
- Check the total expense ratio (TER) of both the FoF and its underlying funds. Higher costs can reduce your returns.
- Review the fund manager’s track record. The performance of a FoF depends heavily on the skill of its manager.
- Look at the underlying funds. Make sure the FoF isn’t just investing in funds you could easily buy yourself, or in funds with overlapping portfolios.
- Assess your own needs. If you’re looking for simplicity, diversification, and professional management, FoFs can be a good fit. If you want more control and lower fees, consider building your own portfolio.
Final Thoughts
A Fund of Funds is like a ready-made investment thali-curated by experts, diversified across multiple funds, and designed for convenience. It’s a great option for beginners, busy professionals, or anyone who wants broad exposure without the hassle of managing multiple investments.
But remember, convenience comes at a cost. Double-layered fees and less control are the trade-offs. So, weigh the pros and cons, check the costs, and see if a FoF fits your financial goals.
If you want a one-stop solution for diversification and professional management, FoFs are worth considering. But if you’re willing to put in the effort, building your own portfolio of mutual funds could save you money and give you more control.
Remember, there’s no one-size-fits-all in investing. The right choice depends on your financial goals, time horizon, risk tolerance, and personal preferences.
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Still Curious?
If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
Investopedia – Fund of Funds (FOF) Explained: How Does It Work? (Blog)
smallcase – Fund of Funds (FOFs): Meaning & How it Works (Blog)
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.
