Fund of Funds (FOFs): Meaning, Types, Pros & Cons

A Mutual Fund scheme that invests in schemes of other Mutual Funds (MFs), is known as a Fund of Funds. Much like how funds invest in stocks and bonds, a Fund of Funds invests in other Mutual Fund schemes.

Consider this example. You bought several clothes from various stores. If you want to return or report problems with two or more of these pieces of clothing, you must go to all the stores separately, wasting time and effort.Instead, if you buy from stores that host multiple brands under the same roof, you need not worry about going to numerous stores to report your grievances. That particular store will approach the various brands and address your needs.Similarly, a Fund of Funds is a Mutual Fund scheme, which invests in other MF schemes. The fund manager builds a portfolio of other Mutual Funds instead of directly investing in securities. The most significant advantage here is that people can find a variety of schemes under one roof.Here, they need not keep track of multiple Mutual Fund schemes. Instead, they need to invest in a scheme that takes care of multiple schemes under it. Fund of Funds is also known as multi-manager investment.

A Fund of Funds is an excellent tool for small investors with limited money who are risk averse and want greater diversification of funds.

• Higher Diversification: A Fund of Funds allows investors a higher degree of diversification since they invest in multiple schemes that invest their corpus in various underlying assets.
• Low investment amount: The investment amount with a Fund of Funds is less. So, people can enjoy the benefits of multiple assets under one roof through it.
• Due diligence of experienced fund managers: Fund managers manage the multi-manager investment schemes diligently, verifying the credentials of the various schemes run by the fund house and its fund managers.
• SIP (Systematic Investment Plan): Like many Mutual Fund schemes, a Fund of Funds offers an SIP investment mode. Through SIP, investors can leverage the benefits of compounding, rupee cost averaging, and so on.

Also Read: How Do Fund Managers Manage Your Mutual Fund Investment?

• High Expense Ratio: Like other Mutual Fund schemes a Fund of Funds also incurs expenses. But unlike Mutual Funds, there is extra cost involved. Apart from the usual management and administrative expenses, there is an added expense of the underlying funds.
• Tax implications: According to the investor's income tax slab, short-term capital gains tax would be applicable if sold before 36 months.

A Fund of Funds is an investment instrument that collects investor money and invests it in various underlying funds in a diversified portfolio. A Fund of Funds takes positions in other funds, such as Mutual Funds, hedge funds, private equity funds, or exchange-traded funds (ETFs), instead of investing directly in specific stocks. A Fund of Funds’ primary goal is to give investors wider exposure to multiple asset classes and investment methods. Also Read: ETF vs FoF: Key Differences

Diversification

By distributing investor cash throughout several underlying funds, a Fund of Funds decreases risk by distributing it among several asset classes, industries, geographic regions, or investment philosophies. Risk reduction and smoother returns are two potential advantages of this diversification.

Fund selection

The Fund of Funds manager does extensive study and due diligence to choose the underlying funds. They consider past performance, risk-management techniques, investment philosophies, fund managers' qualifications, and fees. The objective of the Fund of Funds manager is to put together a portfolio of funds that work well together and support the Fund of Funds' investing objectives.

Asset allocation

A Fund of Funds’ investment mandate states the fund's management decides how to best distribute investors' funds among various asset classes or investment strategies.The allocation choices consider market circumstances and the Fund of Funds’ investment objectives as they attempt to strike a balance between risk and return.

Rebalancing and monitoring

The Fund of Funds manager constantly monitors the efficiency and risk of the underlying funds. To preserve the intended portfolio balance, they may, if necessary, change the fund allocation or selection. Rebalancing entails purchasing or disposing of holdings to achieve the desired asset allocation.

Reporting and Fee Structure :

The Fund of Funds regularly updates investors on performance and offers details about the underlying funds. According to the Fund of Funds’ structure, management fees, administrative costs, and maybe performance-based fees are among commonly charged expenses.The potential advantages of investing in a Fund of Funds include access to a professionally managed, diversified portfolio, reduced time and effort needed to choose individual funds, and the opportunity to invest in strategies or asset classes that might not be available to individual investors.Before making an investment decision, it is essential to carefully evaluate a Fund of Funds’ investment strategy, past performance, fees, and risks. Like with any investment, there could be drawbacks, such as the possibility of over-diversification and the layering of costs. Investors considering investing in a Fund of Funds must thoroughly understand the Fund of Funds’ objectives.

The top Fund of Funds list in the nation comprises the following:

Asset Allocation Funds :

These funds comprise various assets, including stock, debt, precious metals, and other securities. The generally stable investments in the portfolio enable asset allocation funds to achieve significant returns through the best-performing instrument while lowering their risk.

Gold Funds :

Investing in several Mutual Funds that specialise in trading gold-related products. Depending on the asset management firm in question, the Fund of Funds that fall under this category may have a portfolio that includes Mutual Funds or actual gold trading enterprises.

International Fund of Funds:

The main focus of an international Fund of Funds is Mutual Funds that operate overseas. So, investors earn higher returns by investing in the best-performing equities and bonds of the relevant nation.

Multi-Manager Fund of Funds:

The most prevalent variety of Mutual Funds on the market is this one. Such a fund's asset base comprises a variety of professionally managed Mutual Funds, each with a unique portfolio concentration. Typically, a multi-manager Fund of Funds has several portfolio managers, each in charge of a different type of asset in the Mutual Fund.

ETF Fund of Funds:

A ubiquitous financial vehicle in the nation is the Fund of Funds, which includes exchange-traded funds in its portfolio. Investing in an ETF through a Fund of Funds is easier than doing so directly. Buying ETFs requires a Demat trading account , whereas investing in an ETF Fund of Funds has no restrictions, making it a more convenient option.