Fund of Funds – Concept, Features, Types, Benefits, Investment Process & more

In this article, we’ll initiate a thorough discussion over Fund of Funds investment plan, so that you can make a wise investment decision.

Are you searching for the best Mutual Fund plan but are unable to come up with a wise selection? Don’t worry; you aren’t the only one facing this problem.

In this modern era, investment alternatives are mushrooming. You can find a massive list of mutual fund schemes, and each one seduces your money-craving eyes with its attractive offers. 

No wonder every mutual fund scheme comes with a specific set of features to meet the specific requirements. 

Also, you can’t invest in every mutual fund because it will ask you for a big investment. If such things are creating a confusing situation around you!

Undoubtedly, it is time to think about the ‘Fund of Funds’ investment plan. 

What is a Fund of Funds (FOF)?

A Fund of Funds is a unique kind of fund that invests solely in other funds rather than investing in stocks, shares, or other securities.

That’s why these funds are known as a fund of funds. The funds that FOF pick, can be either equity-oriented or debt-oriented, or a mix of them. 

These funds’ primary objective is to reduce the risk probabilities by working on the principle of broad diversification and allocating investment across multiple funds. 

It makes these funds a highly favorable option because, as compared to direct investment in securities, investors invest in a group of funds.

In a nutshell, investors will be investing in a fund that is being managed by expert multi-managers.  

It protects your investment from falling into a severe loss. Often mutual fund schemes can fail due to uncertain factors, e.g., counterparty default or inflation.

But if you are investing in the FOF scheme, you can avoid hazardous outcomes. 

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What are the Features of Fund of Funds (FOF)?

Now, let’s take a quick overview of FOF scheme features to know better about this fantastic FOF scheme: 

Broad Diversification

The broadly diversified portfolio makes the FOF scheme an attractive investment option among investors. For instance, the funds in these FOF scheme investments are already diversified. 

Even the FOF scheme itself doesn’t invest in a single fund but a group of funds to allocate investment effectively. It builds two-layer diversity in the portfolio, which ensures double protection. 

But, often, these funds fail to outperform because broad diversification reduces profitability as well. That’s why fund managers of these funds avoid undertaking over-diversification.  

Risk Exposure

The broad-diversification doesn’t make the FOF scheme completely risk-free. They are moderately risky as these funds only allocate investment across different funds. 

Also, these funds can be less-risky or highly risky, or completely safe. The fund managers of the FOF scheme keep their eyes on all these funds. 

Similarly, they will allocate these funds to multiple funds to create a well-filtered portfolio.

It will also avoid any loss from the funds to turn into a severe loss as other good-performing funds will keep putting off the hazardous impacts. 

Though, over-diversification can be a primary-risk inviting factor, as there are numerous shortcomings associated with it. 

High Expense Ratio

Fund of Funds scheme invests in diverse mutual fund plans. All these mutual fund plans have their own expense charges, and FOF has high expense ratio. 

It leads to an increase in the expense ratio of this scheme. However, to reduce the expense ratio, the fund house utilizes its strategies.

Taxation

These funds are taxed like debt funds, which makes it a remarkable point of the FoF scheme. Even though these funds do invest in equity funds as well, they are still taxed like debt mutual funds.

In most instances, this thing provides relief to the investors because a high expense ratio of the FoF scheme already appears to be a big headache for investors. 

Find details of other Types of Funds here

Types of Fund of Funds Schemes (FOF)

Below we have mentioned some of the most popular Fund of Fund Scheme types in India about which we will discuss below-

Asset Allocation Funds

It is a standard FoF scheme type in which the fund manager invests in funds that include diverse asset pools.

All these funds can include precious metals, debt, or equity instruments to produce higher returns from it. 

However, in this FOF scheme, investors try to pick only those funds with a reduced level of risk with higher-return generating quality.

It is so that the entire portfolio generates a stable income.  

International FOF

These funds predominantly invest in international mutual funds. Though, income from these funds is relatively higher. 

For instance – if the fund manager has picked the best MF plan, he can generate a massive income from that. 

FOF Investing in ETF 

ETF refers to the exchange-traded funds. Investors aspiring to invest in ETF can choose to invest through FoF. 

It provides you rid of opening an additional demat trading account, which is a mandatory condition if you are investing in ETF directly. 

These funds yield higher returns but make sure they can be risky as well due to a close connection with market volatility impact.  

Gold Funds

FoF scheme that allocates a few portions of its funds in Gold trading mutual fund companies and rests in other MF schemes falls into this category. 

Multi-manager Fund of Funds

These funds are, however, the most common type of FoF scheme. Under this Scheme type, multiple managers keep their eyes on every individual fund. 

They take prompt action if the asset is performing good or bad. Hence, these funds can be called professionally managed funds.  

Who Should Invest in Fund of Funds Scheme (FOF)?

It’s no surprise that not all MF schemes can meet every investor’s particular desires. Few of them are probably one of the most sought-after investment plans. 

Still, they aren’t recommended for every investor. If we talk about the Fund of Funds scheme, these funds are relatively the best option for small investors. 

If you have a lower risk appetite, you can invest in this MF plan. The diversified portfolio of these funds provides you a safe investment profile. 

Apart from these things, do remember that Fund of Funds isn’t a short-term investment scheme. They work great for a long-term horizon.

Hence, investors planning to invest in these funds should set a long-term goal of more than 3 or 5 years. 

Find details of all types of Debt Funds here

Benefits of Investing in Fund of Funds

Here are the list of major benefits of investing in Fund of Funds –

A Tax friendly Mutual Fund Plan

Fund of Funds scheme is a tax-friendly investment plan. In the scheme, no tax is levied on the captain gains while rebalancing the portfolio. 

The tax on FoF is also quite similar to the debt funds, even though the scheme is investing in equity funds.

Ease of Handling

These funds are easy to manage due to one folio and one NAV that ensures ease of handling. 

Professionally Managed Funds

Professional managers handle these funds that make them a more reliable option.

Moreover, the funds that this FoF scheme picks are already handled by professionals of the respective fund company. 

Best for small investors

For small investors, these funds are undoubtedly the best option. If you have a small capital to invest in, you can choose the FoF scheme. 

Why is it best? Well, this is because you get an added advantage of a professionally managed portfolio.

These funds comprise a double-protection layer as too many professionals will be handling your small investment.

Things to Consider before Investing in Fund of Funds

Instead of directly jumping into a mutual fund plan, you should consider a few essential points as a smart investor.

If you want to come across a wise decision, remember these few things-

The First Thing to Consider

Typically, the Fund of Funds invests in long-term funds. Hence, you should enter in this MF plan with a long-term vision. These funds can work better for an extensive locking-period. 

Therefore, if you are looking for a short-term investment plan, of course, this option isn’t for you.

Instead, you can choose some other debt mutual funds option that will generate good returns for you.  

The Second Thing to Consider 

The ‘return ratio’ from this mutual fund scheme can be lower as the expense ratio can chop off the ultimate margin. Hence, you shouldn’t enter into this MF plan with a higher return expectancy. 

Though, these funds will keep your investment safe for a longer time. Still, it depends upon the expertise of the fund managers. 

If the portfolio isn’t working well, it may lead to unfavourable outcomes. Market volatility can also negatively impact the performance of these funds. 

Check out all types of Hybrid Funds here

How to Invest in Fund of Funds Scheme?

If you want to invest in a Fund of Funds scheme, then there are mainly two methods you can use for investments:

Online

The online method is the most economical and friendly approach to invest in the FoF scheme. 

You can either use the official website or app of a reliable company for investment. Else you can choose digital broker websites.  

Offline 

The offline method is a conventional approach to start investing. 

Hence, if you want to invest in the Fund of Funds scheme, visit a nearby fund house and connect with a broker. Give them the required documents, fill-up the form, and start investing.  

Drawbacks of Fund of Funds Scheme

Here are few drawbacks of investing in Fund of Funds Scheme –

Higher Expense Ratio

The one thing that makes the ‘FoF scheme’ an unfavourable option is its high expense ratio. However, charges can be relatively lower in the fund house. 

But other factors are more likely to increase the expense ratio. If the pooled funds in FoF are imposing a higher expense ratio, the ultimate expense ratio will be higher. 

The extra cost involved in these funds can be another negative point.  

Over-Diversification

Over-diversification can negatively impact the performance of a portfolio. It may reduce the ultimate margin as the added costs and the expense ratio will raise problems. 

However, many funds repeat the same assets in most instances, making diversification strategy an ineffective approach.  

Fund of Funds or FoF Scheme – Conclusion

It’s no surprise that Fund of Funds is a unique type of MF scheme. These funds can be a way better option for risk-averse investors.

Even though you are a small investor with limited capital for investment, the FoF scheme comes with great benefits. 

From tax advantages to a professionally managed portfolio, these funds offer you much more than your expectations. 

Though, there are few negative aspects of this MF scheme that make it a less attractive option. Such as, higher expense ratio and over-diversification can make this investment plan less effective. 

Still, if you seek the best long-term investment plan that ensures the safekeeping of your money, undoubtedly, this scheme is absolutely for you.

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