A Fund of Funds i.e. FOF is an investment strategy where the investor holds a portfolio of other investment funds instead of investing in stocks directly. When an individual invests in FOF, they get the benefit of a diversified investment portfolio. Investing in FOF gives investors exposure to various asset classes that too at a lower risk. As per the Income Tax Act, the tax treatment of a FOF is the same as that of tax on debt mutual fund even though it may invest in equity-oriented fund.
What is Fund of Funds (FOF)?
A fund of funds also known as a multi-manager investment is a pooled investment fund that invests in other types of funds. In simpler terms, a fund of funds is a mutual fund that invests in various other mutual funds present in the market.
The most important feature of these types of mutual funds is that these funds are managed by highly trained professional portfolio managers who can accurately predict the market condition to minimize the chances of loss. They are mutual funds that have different kinds of portfolios depending upon the main aim of the fund manager. For example, if the aim is to earn higher returns and yields, then the target will be mutual funds that have higher NAV. Similarly, if the aim is stability, then mutual funds that are low-risk will be the target.
These mutual funds can invest in both domestic and international funds. This gives them the benefit of diversification and helps in improving the yield of the fund.
Taxation on Fund of Funds (FOF)
The tax treatment of FOF is similar to that of tax on non-equity funds. Even if the FOF invests in equity-oriented funds, the tax treatment of FOF would be as per non-equity funds and not equity funds. Following is the income tax on FOF:
|Capital Gain||Period of Holding||Tax Rate|
|Long Term Capital Gain||Holding Period > 36 months||Section 112 – 20% with Indexation benefit|
|Short Term Capital Gain||Holding Period <= 36 months||Slab Rates|
Types of Fund of Funds (FOF)
Asset Allocation Funds
Asset Allocation Funds are balanced mutual funds where the investment is done in diverse securities like equity, debt, gold, etc. Investing in a diverse asset pool helps the asset allocation funds to perform better and generate higher returns at a low-risk level.
In gold funds, the FOF invests in mutual funds that are primarily trading in gold securities. Depending upon the asset management company, this category of FOF can invest in mutual funds or gold trading companies directly.
International Fund of Funds
International FOF are funds that invest in mutual funds that are operating in foreign countries. These funds allow the investors to yield higher returns via the best-performing stocks and bonds of different countries.
Multi-Manager Fund of Funds
The most common type of FOF is a multi-manager fund of funds. These funds include various professionally managed Mutual Funds having a different portfolio concentrations. Such FOF has more than one manager, with each handling a specific asset of their expertise.
ETF Fund of Funds
ETF (Exchange Traded Funds) FOFs are mutual funds that invest in shares in the stock market making it a higher-risk fund as they are subject to market risk. If one wants to invest directly invest in ETFs they require a Demat trading account while investing in ETF FOF has no such limitations. Hence, investing in an ETF via a FOF is a more sought option than a direct investment in this instrument.
Advantages of FOF
There are several benefits of investing in FOF:
FOFs gives the opportunity to a higher degree of diversification as these funds invest in multiple schemes that in turn invest their corpus in various underlying assets.
Low Investment Amount
The amount of investment in a fund of funds is less compared to other investment instruments. Hence, investors with limited finance can also benefit from multiple assets under the same roof.
Experience Fund Managers
FOF mutual fund schemes is managed by highly professional personnel who perform thorough market research to yield higher returns.
Drawbacks of FOF
Following are the limitations of investing in FOF:
High Expense Ratio
Just like any other mutual fund, a FOF also incurs expenses. However, unlike funds of funds incur additional costs. Apart from the usual management and administrative expenses, they also have to incur costs of the underlying funds that they invest in.
Tax will be levied on the FOF during the time of redemption of the principal amount. They will attract long-term or short-term capital gains as per the holding period of the funds. It is to be noted that the dividend received on this investment is not taxable, as the burden is borne by the issuing fund house.
Difference between ETF and FOF
|Category||Fund of Funds||ETF|
|NAV vs Market Value||Units of FOF are bought or redeemed at NAV||ETF is traded on a stock exchange at the Market price of each lot of share or fund|
|Liquidity||Might take few hours to days to get the money||Bettter liquidity compared to FOF|
|Taxation||FOF are taxed same as Debt Funds||ETFs are taxed as per their asset allocation|
Fund of Funds i.e. FOF is an investment strategy where the investor holds a portfolio of other investment funds instead of directly investing in stocks. FOF provides the benefit of a diversified investment portfolio at a lower risk. A FOF Scheme primarily invests in the units of another Mutual Fund scheme.
As per income tax in India, FOF is treated as a non-equity fund. Below is the tax treatment:
Period of Holding – 36 months
LTCG if the taxpayer holds it for more than 36 months and is taxable at 20% with the benefit of indexation.
STCG if the taxpayer holds it for up to 36 months and is taxable at slab rates.