What is Fund of Funds?

What is Fund of Funds?

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Features and benefits of the Fund of Funds scheme

Key Takeaways

  • A Fund of Funds is a pooled Mutual Fund scheme investing in other hedge or Mutual Funds.
  • Like all Mutual Funds, FoFs help investors with portfolio diversification.
  • Investors can accrue significant returns at moderate risks.
  • Costs related to Fund of Funds are higher due to investments in numerous schemes.
  • You should consider staying invested for more than three years for decent returns from Fund of Fund investments.

Are you a young investor? Do you want to diversify your portfolio but are confused about where to begin? Then the Fund of Funds investment scheme is for you. A type of Mutual Fund scheme that enables you to diversify your investments to minimise risk, Fund of Funds are incredibly popular among investors. Keep reading to know what is Fund of Funds and how it helps tackle the diversification conundrum.

Fund of Funds – Meaning and Example

Fund of Funds (FoF) is a unique Mutual Fund scheme that invests in Hedge Funds and other Mutual Funds instead of investing directly in stocks or other asset classes. For instance, when you invest in a Debt Mutual Fund, the fund manager invests your money directly into debt and debt-related instruments. In the case of FoF, the fund manager will first allocate funds to a Mutual Fund scheme, and then the Fund of Funds Mutual Fund scheme will invest in funds of equity, debt or mixed mutual funds.

What Makes Fund of Funds Different?

So, what difference does it make if you directly invest in stocks and bonds? Essentially, Fund of Funds assist with portfolio diversification to reduce the overall risk. The FoF will invest in the mutual fund schemes of the same fund house or different fund houses.

The fund categories of Fund of Funds in India are asset allocation funds, gold funds, foreign FoFs and multimanager investment FoFs.

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Benefits of Fund of Funds Scheme

Onboarding

Fund of Funds is an excellent means to kickstart your investment journey. Experienced fund managers professionally manage your fund on your behalf.

Diversification

FoF focuses on the top-performing Mutual Funds across assets or sectors, thus enabling you to optimise returns and reduce risks. They also invest in Hedge Funds.

Tax-free

Capital gains are income tax-exempt when the fund manager rebalances your FoF allocation between debt and equity fund.

Things to Consider

Cost

FoFs invest in other Mutual Funds; therefore, you may have to bear the expense ratio of all other Mutual Funds along with fund manager commissions and other related management fees.

Taxation

Short-term capital gains are applicable for FoFs held within three years and are taxed per your income tax slab. Long-term capital gains for FoFs held for more than three years are taxed at 20% with indexation.

Excess diversification

Diversification helps you reduce or mitigate your investment portfolio risks. However, excess diversification may not be ideal so ensure you are careful while selecting fund of fund schemes.

Investment horizons

Fund of Funds in India perform well when held for the long term – typically for investment horizons of three years or more based on market conditions.

Conclusion

The Fund of Funds scheme is ideal for investors looking for ways to diversify their portfolios without the hassle of timing the market or checking the NAV of all schemes. A well-diversified investment portfolio generates good returns at moderate risk. Ensure you consider costs, risks and investment goals and make informed decisions before investing in FoFs.

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*Disclaimer: This article is for information only. We recommend you get in touch with your income tax advisor or CA for expert advice.

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