What is Fund of Funds in Mutual Funds?

Fund of Funds in Mutual funds invests in other mutual funds to diversify your portfolio
So let’s say you want to invest in 3-4 mutual funds, so instead of investing in them separately, if there is a FoF that invest in these mutual funds, than you can invest in this single FoF
These funds can invest in in the mutual funds belonging to same fund house or different fund houses
They can also invest in funds belonging to foreign fund houses
Due to investment in various mutual funds, these funds have low risk and provide diversification to your portfolio
They can either belong to equity mutual funds if they invest in a list of equity funds or debt mutual funds if they invest in funds with debt instruments
One limitation is that FoF usually have high expense ratio

Let us now see how FoF work.

How Fund of Funds Works?

The working of FoF in mutual funds is quite simple:

The fund manager selects multiple mutual funds to be included in the FoF
These funds can belong to equity or debt or both types of instruments
The goal of the fund manager is to select the mutual funds as per risk appetite and profile that is mandated as per this mutual fund rule
Your assets allocated to this FoF are invested in this list of mutual funds to provide diversification
So let’s say you want to invest in large cap and small cap index mutual funds and you done want to invest in them separately. If there is a fund of fund (FoF) that invest in these two indices, you can select this fund of funds and with just one investment you fulfill your needs

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Types of Fund of Funds

There are various types of Fund of Funds in Mutual Funds mentioned below:

Asset Allocation Funds

Asset Allocation funds are the type of FoF that invest in various assets like equity, bonds, gold, commodities and precious metals. The goal is to diversify the portfolio to get better returns with low risk by investing across various asset classes

Gold Funds

These fund of funds invests in physical or virtual golds and even companies that trade in gold or who are involved in mining of gold. So those mutual funds that usually deal in gold investments are included in this FoF.

Multi Manager Fund of Funds

This is the common type of FoF in which the investments are made in multiple mutual funds, each of which is manager by professional fund manager who is assigned to those individual mutual funds. These individual mutual funds invest the investors money in classes such as pure equity, or pure debt of hybrid mutual funds.

In this fund of funds you get the advantage of have a portfolio of mutual fund with just one mutual fund selected.

International Fund of Funds

These funds invest in mutual funds of foreign countries. This gives the opportunity to take advantage of stocks and bonds of other countries that are performing well, to give you high returns.

ETF fund of funds

Investing in ETF fund of funds gives you an advantage of investing in multiple ETF without having a Demat account. The limitation of ETF fund is that you need to have a Demat account and ETF tend to be volatile as they are bought and sold in open market like stocks. Where as ETF FoF will avoid the volatility that you have to face.

So above are the various types of fund of funds in India.

Advantages of Fund of Funds

Below are some benefits of investing in fund of funds:

Diversification: Since FoF invest in multiple mutual funds, these funds provide diversification with your investment since your money is invested in various asset classes and not in one stock or mutual fund
Investment with Low Capital: In case you want to invest in 3-4 mutual funds with limited amount of Rs. 2000 per month, you can invest in a FoF that invest in these 3-4 mutual funds with limited capital every month, thus achieving your goal to invest in multiple funds with just one mutual fund
Multiple Professional Managers: Fund of funds invest in other mutual funds that are manager by professional fund managers which tries to maximize the returns from underlying stocks under their mutual funds, so you get the opportunity to use experiences from multiple professional managers

ALSO READ: Ideal Portfolio of Mutual Funds

Disadvantages of Fund of Funds

There are certain limitations while investing in fund of funds:

High Expense Ratio: The expense ratio of fund of funds is high compared to standard mutual funds, because it involves in selecting multiple mutual funds from various asset classes and to deploy your investments as well, apart from handling the amount and fees of the fund managers
Income Tax: You need to pay income tax on the redemption of the mutual fund units only on the profits made and not on the principal amount. The tax can be on short term capital gains or long term capital gains based on the tenure of investment done
Over Diversification: Even when your investments are diversified, it can lead to overdiversification if you are already investing in couple of mutual funds and want to invest in FoF which also invests in those mutual funds that you are already investing

Things to consider as an Investor

As an investor you need to check the expense ratio of funds of funds and also the list of mutual funds that these funds invests in. You need to select the experienced fund manager that will invest as per your risk appetite and consider other tax implications as well.

You need to check whether you are not over diversifying your portfolio of mutual fund investments when opting for FoF.

Conclusion

So fund of funds in mutual funds helps you to invest in a list of mutual funds based on your risk appetite. So instead of having multiple mutual funds in your portfolio, you can select a single FoF mutual fund that invest in multiple funds for you.

Some more Reading:

Frequently Asked Questions

What is the full form of ETF and FoF?

ETF full form is Exchange traded funds which are bought and sold in open market and are volatile in nature. FoF full form is Fund of Funds that invests in list of mutual funds in order to diversify your portfolio.

What is Fund of Funds with example?

Some of the examples are ICICI Prudential Thematic Advantage Fund (FOF), Aditya Birla Sun Life Financial Planning FOF Aggressive Plan, Quantum Multi Asset Fund of Funds, etc.

What is the use of fund of funds?

Fund of Funds help you to diversify your investments by investing in multiple mutual funds with the help of just one mutual fund. This helps you to take advantage to investing your money across various asset classes.

What is the difference between ETF and fund of funds?

Investing in ETF FoF gives you an advantage of investing in multiple ETF without having a Demat account. The limitation of ETF is that you need to have a Demat account and ETF tend to be volatile as they are bought and sold in open market like stocks. Where as ETF fund of funds will avoid the volatility that you have to face.

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