When you wish to diversify your investments without taking care of tons of funds, a Fund of Funds (FoF) could be a solution. It is like hiring a fund manager who picks the best-performing mutual funds for you. Here, let us understand what is fund of funds, how they work, the types of FoF, and why it could be something to consider adding to your portfolio.

What is Fund of Funds (FoF)?

Let us understand fund of funds meaning. In simple words, it is a mutual fund that invests in other mutual funds offered by the same or other mutual fund houses.

Understanding the Core Idea of FoF Mutual Fund

Instead of purchasing stocks, bonds, or securi­ties directly, a mutual fund FoF invests your money for you in a collection of other funds. All of these underlying funds can have diverse strategies – equity, debt, international exposure, or theme-based-sectoral.

At its core, Fund of Funds offers you instant diversification since your money is invested across a number of strategies and fund houses with just one investment.

Types of Fund of Funds (FoFs)

A FoF mutual fund is not a one-size-fits-all concept. For different goals, there are different types to consider.

1. Asset Class-Based FoFs

These invest in equity funds, debt funds or hybrid funds. The goal is to balance risk and return through various asset classes.

Example: For a moderate-risk portfolio, a FoF may invest 60% in equity mutual funds and 40% in debt mutual funds.

2. International FoFs

This FoF mutual fund invests in funds overseas and allows you to invest in global markets without the need to open a foreign investment account.

You can participate in the rise of global tech giants and invest in growth in emerging markets, diversifying beyond Indian markets.

3. Strategy-Based FoFs

These FoFs are based on a particular investment strategy, such as value investing, momentum or thematic strategies, by selecting mutual funds that correspond with that strategy.

4. ETF-Based FoFs

ETF-based Fund of Funds invests in Exchange-Traded Funds (ETFs) in place of mutual funds. These are usually low-cost and follow indices such as Nifty or Sensex. These are a great option for passive investors seeking long-term market-linked returns with low expense ratios.

Key Advantages of Fund of Funds

Now that we understand the fund of funds meaning, let us move to understand the benefits of FoFs. The most significant benefit of a FoF mutual fund is its simplicity. Let’s consider how it’s advantageous for novices and experienced investors alike.

1. Instant Diversification

The biggest advantage of these funds is diversification across fund managers, asset classes and geographies. Even if one mutual fund does not perform well, others may offset it. So, the bottom line is diversification lowers your total portfolio risk and makes returns more consistent over time.

2. Professional Fund Selection

Picking among hundreds of good funds is not easy. FoFs are managed by professional fund managers who analyse the performance, consistency and strategy of funds. You get institutional-quality research without having to do the homework.

3. Access to Global Investments

If the FoF mutual fund invests internationally, you can invest in US, European or Asian markets, too. As mentioned earlier, this is the easiest way to diversify internationally without violating local restrictions.

4. Ideal for SIP Investments

Do you want to create long-term wealth through SIPs (Systematic Investment Plan) ? A FoF enables you to get started with smaller amounts and diversify across a range of funds and investment strategies using your regular contributions on a monthly, quarterly or any other periodic basis.

Important Considerations Before Investing in a FoF

While the benefits are numerous, anyone considering investing should also know the other side of the coin before diving into Fund of Funds.

1. Double Expense Ratios

The total cost might add up to a bit more than investing in one mutual fund because you’re investing in funds that charge fees. The FoF has its own fee management in addition to the expense ratio of the underlying funds.

2. Taxation Rules

FoFs (other than FoFs that invest only in Indian equity funds) are subject to tax, similar to debt funds. This requires longer holding periods to take advantage of long-term capital gains. If you are looking for tax efficiency, make sure the FoF structure is suitable for your goal.

3. Performance Depends on Underlying Funds

In case the mutual funds chosen do not perform, your FoF will not perform as you expect. That is why it is essential to verify the historical consistency and the background of the fund manager.

4. Liquidity and Exit Load

While FoFs are mostly liquid, some could levy an exit load if redeemed within a certain time. Furthermore, international FoFs may have delayed settlement, impacting liquidity in turbulent markets.

Who Should Consider a Fund of Funds?

A FoF mutual fund is not for everyone, but it can be benefitting for certain investors.

1. First-Time Investors

If you’re not comfortable choosing good funds or need diversification from day one, FoFs are a great place to begin investing.

2. Time-Strapped Professionals

Don’t have the bandwidth to monitor and rebalance several funds? A fund of funds does that for you.

3. Risk-Averse Investors

Want to spread out risk across fund houses and asset classes? FoFs also provide in-built risk management through diversification.

4. Global Diversification Seekers

If you want to add international exposure, global FoFs are the easiest way to do so, as they need no foreign account or paperwork.

Conclusion

FOFs combine the best features of several funds in one convenient package, providing diversification, ease of use, and global exposure.

If you're new to investing or just want a more hands-off method, a FoF mutual fund can make it easier to invest according to your long-term goals.

Just keep in mind: like any investment, one needs to consider fees, tax implications and past performance. But with the right fit, a FoF can be a great addition to your wealth-building tool. So, if you have not explored this investment opportunity yet, consider doing some research and levelling up your investment.

Sources:

• https://www.etmoney.com/learn/mutual-funds/fund-of-funds-fof/

• https://groww.in/mutual-funds/other-schemes/fund-of-funds

• https://www.zerodhafundhouse.com/blog/fund-of-funds-meaning-types-and-advantages/

SIP does not assure a profit or guarantee protection against loss in a declining market. The illustration mentioned above is not based on any judgements of the future return of the debt and equity markets / sectors or of any individual security and should not be construed as promise on minimum returns and / or safeguard of capital. Information gathered and material used in the above illustration is believed to be from reliable sources.

The Tax calculation shown above is for illustration purpose and general information only. Investors are advised to consult their Tax Consultant or Financial Advisor to determine tax benefits applicable to them.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.