What is a Fund of Funds?
A Fund of Funds is a kind of mutual fund scheme that essentially invests in a collection of mutual funds, and sometimes in hedge funds as well. The fund’s investment portfolio consists of mutual fund schemes rather than equity and debt securities. Owing to an additional layer of fund management, these funds are frequently referred to as multi-manager investment.
In India, FoFs are typically mutual funds investing in overseas mutual funds or ETFs (Exchange Traded Funds). The benefit of investing in a fund of funds is the extra layer of professional management and added diversification which provides an opportunity to a small trader to invest in different classes of assets.
Table of Contents :
Features of Fund of Funds (FoF)
1. Diversification
One of the key benefits of investing in a FoF is the diversity of funds and assets it offers. There is a two-layer diversity in these funds. First, there is an allocation to a diverse set of mutual fund schemes. Secondly, the invested schemes invest in diverse assets such as equity and debt securities. It should be noted that sometimes over-diversification might do more harm than good, as the potential gains decrease in an effort to reduce market risk.
2. Risk Exposure
FoF is regarded as a moderately risky instrument. Investment in a diverse set of schemes immunes the portfolio from potential market risk. Allocation to different asset classes lowers down the risk from a specific asset class, such as market risk from equity investment or credit risk & interest rate risk from debt investment.
However, there is a possibility of risk arising out of over diversification of the investment portfolio, and also overlapping of asset classes. The latter means that if a fund invests in two mutual fund schemes, and both have significant allocation to equity securities, the overall market risk of the fund increases. It might incur losses if the overall market plunges.
3. High Expense Ratio
Owing to investment in multiple mutual fund schemes, which have their individual expense ratios, FoF has a high expense ratio as it factors in the cumulative expense ratio of the underlying funds as well. Investors should consider this aspect as well before investing in FoF.
4. Taxation
FoF are taxed just like any other debt mutual fund scheme, even though the fund invests in equity mutual fund schemes. If you withdraw before 3 years of investment, Short Term Capital Gains are added to the taxable income and taxed as per the income tax slab of the investor. The Long Term Capital Gains are taxed at 20% with the benefits of indexation.
Types of Fund of Funds Schemes
1. Fund of Fund Investing Overseas
This type of Fund of Fund (FoF) invests in international funds which are registered in foreign countries. These foreign funds, in turn, hold foreign stocks. This way the FoF enables Indian investors to get exposure to foreign stocks such as Alphabet (Google), Apple, Microsoft, General Motors etc.
For example, DSP US Flexible Equity Fund invests in Blackrock Global Funds – US Flexible Equity Fund, an international fund managed by Blackrock.
2. Fund of Funds Investing in ETFs
FoFs also give investors access to ETFs. An ETF (Exchange Traded Fund) invests in stocks, bonds or commodities like gold. It is not sold like an ordinary mutual fund but is rather traded continuously on the stock exchange. However, Investors need demat and trading accounts to invest and trade in ETFs. This leaves out a large section of investors from the ETF market. As a result, mutual fund houses have created FoFs to give retail investors access to ETFs.
For example, Nippon India Gold Savings Fund is a FoF which invests in India’s largest gold ETF, Nippon India ETF Gold BeES.
Who should invest in a Fund of Funds?
Investors who wish to capitalize from investment in a multitude of mutual fund schemes, by investing in a single scheme can opt for Fund of Funds. These investors can benefit from the diversification and multi management facets of FoF.
Since there is significant allocation to equity securities, investors should have a moderate risk appetite to invest in FoF.
How to invest?
There are two ways through which a person can invest in Fund of Funds:
1. Online
You can invest in Fund of Funds online seamlessly through online platforms (such as Paisabazaar.com) or directly through the websites of the Asset Management Companies (AMCs), offering the fund.
2. Offline
This conventional mode of investment requires an investor to fill a form and submit it at the nearby branch of the fund house, or invest through a broker.
To know more about the investment procedure for mutual funds, visit: How to invest in Mutual Funds?
Best Funds of Funds to Invest
Here is a list of top 5 Funds of Funds that have shown consistent performance and one can consider investing in these funds:
| Fund Name | 1- Year Returns | 3 – Year Returns | 5 – Year Returns |
| DSP US Flexible Equity | 17.15% | 13.82% | 12.40% |
| Quantum Equity FoF | 15.67% | 9.04% | 8.36% |
| Nippon India Gold Savings | 23.02% | 11.10% | 8.13% |
| Franklin India Life Stage FoF – 40s | 7.64% | 6.81% | 7.60% |
| IDFC Asset Allocation FoF | 11.92% | 7.52% | 7.49% |
{Funds have been ranked based on 5- Year Annualized Returns}
{Data as on February 21, 2020; Source: Value Research}