What Are Fund Of Funds Mutual Funds And How Do They Work? (2024)

A fund of funds mutual fund or an FoF is a mutual fund that invests in units of other mutual funds, rather than investing directly in stocks, bonds or other investment securities. In India, there are FoFs which specifically invest in overseas mutual funds or Exchange Traded Funds (ETFs) too.

Types of Fund of Funds Schemes

i) Investing Overseas

This type of Fund of Fund (FoF) invests in foreign funds registered abroad. As these foreign funds hold foreign stocks, an Indian investor gets exposure to foreign stocks by investing in a Fund of Fund that invests in foreign funds.

ii) Investing in ETFs

FoFs also invest in Exchange Traded Funds (ETFs). An ETF invests in stocks, bonds or commodities like gold. Unlike an ordinary mutual fund, ETFs are not sold but are traded continuously on the stock exchanges. Investors, though, have to have a demat and a trading account to invest and trade in ETFs.

Additionally, there are asset allocator or multi-asset funds, international fund of funds, ETF-based fund of funds, gold fund of funds, easy rebalancing fund of funds and diversification fund of funds.

Advantages of FoF

There are many advantages of investing in FoF and the risk profile of an FoF is moderate. This is so because one, an FoF invests in units of other mutual funds. So an FoF automatically gets diversified. First, because the mutual fund and FoF buys units of itself and has investments in equity and debt.

An FoF can buy as many mutual funds as it wants to. They can be sectorally different and they can also invest in mid-cap and large-cap Two, since FoF buys into units of other mutual funds, it might have invested in units of debt mutual fund, equity mutual fund, gold ETF and real estate mutual fund. In a particular time frame, if an equity mutual fund performs well but debt mutual fund does not, an investor in FoF may not suffer much as the loss making debt asset will be balanced by the profit making equity asset.

FoFs are also known as multi-manager investments as these are managed by at least two sets of fund managers – one, the fund manager of the original mutual fund whose units are bought by the FoF and the other the fund manager of the FoF itself. Thus, an investor in FoF gets the advantage of her funds being managed by two sets of expert fund managers.

You may ask, why should you invest in an FoF when you can directly invest in a mutual fund? The answer to this question is, if you are just starting out with your investments in mutual funds, investing in an FoF will give you good experience as to all kinds of mutual funds rather than exposing you to the risk of investing in just one kind of mutual fund that may or may not perform well.

Disadvantages of FoF

However, the multiple mutual fund schemes that an FoF invests into have their individual expense ratios. Since FoF has also to consider the cumulative expense ratio of the underlying funds, it has a high expense ratio. Further, investors have to bear the recurring expenses of the relevant fund of fund scheme in addition to the expenses of the underlying schemes in which the fund of fund scheme invests.

One major disadvantage of investing in FOF is that investors cannot choose the mutual funds that FoF invests in. The fund manager of the FoF chooses to invest in units of particular mutual funds or the investment strategy of FoF decides where to invest. So, if an FoF has invested in ten mutual funds, then you automatically get exposed to those ten funds.

There could also be duplication. As FoFs invest in different mutual funds, there could be a possibility that two or more mutual funds in which the FoF has invested in, have exposure to the same stocks or debt securities.

Taxation could be another disadvantage of FoFs. For tax purposes, most FoFs are treated like any other debt mutual fund scheme, even if the funds are invested in equity mutual fund schemes. If you withdraw your investment from FoF earlier than three years, short term capital gains tax as per the income tax slab of the investor will be applicable. Long term capital gains tax at 20% with the benefits of indexation will also apply.

However, Fund of Funds will absorb the tax implication involved while buying and selling the units of mutual funds and so the overall tax impact on the investor will be lower.

Who Should Invest in FOFs?

Investors who wish to take advantage of diversified investment and multiple fund managers can invest in Fund of Funds. Those who have a moderate risk appetite can also invest in FoF as it invests a significant amount of funds in equity.

FoF is a good investment option for even a novice as the investor gets to learn about how different mutual funds perform and gain confidence to invest directly in mutual funds and later in equity.

How to invest?

One can invest in a FoFs online or offline. Investors can invest through SIPs or through lump sum investment. Alternatively, an investor can simply fill up the physical form and submit it at the nearby branch of the fund or invest through a broker.

Bottom Line

It is better to check before investing in an FoF that there isn’t a lot of duplication of portfolios either within the mutual funds that the FoF invests in or one’s own portfolio. And in overall strategy, it is most important to ensure that all your investments are well-aligned with your risk profile and fit into your overall asset allocation strategy. Diversification and aligning your investments with your risk profile are the key to successful investments.

Saurav heads the wealth management business at Tata Capital. He has more than 20 years of experience in the financial services sector. Prior to joining Tata Capital, he worked with Citibank and Philips India. Saurav is an alumnus of Indian Institute of Management, Lucknow and National Institute of Technology, Suratkal.

Aashika is the India Editor for Forbes Advisor. Her 15-year business and finance journalism stint has led her to report, write, edit and lead teams covering public investing, private investing and personal investing both in India and overseas. She has previously worked at CNBC-TV18, Thomson Reuters, The Economic Times and Entrepreneur.