Fund of Funds – Meaning, Types and Benefits

When an individual invests in fund of funds they at once get the benefit of a diversified investment portfolio. Investing in fund of funds gives investors exposure to various asset classes that too at a lower risk. This article will help you understand various aspects related to funds of funds.

What is Fund of Funds?

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. Fund of funds are mutual funds that have different kind of portfolio 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 fund of funds 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.

Types of Fund of Funds

Following are the various type of fund of funds prevailing in India:

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.  

Gold Funds

In gold funds, the fund of funds invests in mutual funds that are primarily trading in gold securities. Depending upon the asset management company, this category of fund of funds can invest in mutual funds or gold trading companies directly.

International Fund of Funds

International fund of funds is those 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 fund of funds is a multi-manager fund of funds. These funds include various professionally managed Mutual Funds having a different portfolio concentration. Such fund of funds has more than one manager, with each handling a specific asset of their expertise.

ETF Fund of Funds

ETF fund of funds 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 fund of funds have no such limitations. Hence, investing in an ETF via a fund of funds is a more sought out option than a direct investment in this instrument.  

Advantages of Fund of Funds

There are several benefits of investing in Fund of Funds;

High Diversification

Fund of funds 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 as compared to other investment instruments. Hence, investors with limited finance can also benefit from multiple assets under the same roof.

Experience Fund Managers

Fund of funds mutual fund schemes is managed by highly professional personnel who perform thorough market research to yield higher returns.

Drawbacks of Fund of Funds

Following are the limitations of investing in fund of funds;

High Expense Ratio

Just like any other mutual funds, a fund of funds 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 Implication

Tax will be levied on the fund of funds during the time of redemption of the principal amount. Fund of funds 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 Fund of Funds

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 
Expense Ratio  High Low
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