Funds of Funds (FoFs) are a unique type of mutual fund that, instead of investing directly in stocks, bonds, or other individual securities, invests in the units of other underlying mutual funds (or Exchange Traded Funds – ETFs).
Think of it as a “mutual fund of mutual funds.”
How do Funds of Funds work?
- Pooled Investment: Investors put their money into the Fund of Funds.
- Manager’s Role: The FoF’s fund manager then uses this pooled capital to buy units of various other mutual funds or ETFs, which may be managed by the same Asset Management Company (AMC) or different AMCs.
- Indirect Diversification: By investing in multiple underlying funds, the FoF provides investors with a highly diversified portfolio across different asset classes, investment strategies, geographies, or market capitalizations, all through a single investment.
Key Characteristics:
- Layered Structure: There are two layers of management:
- The FoF’s own fund manager who selects and monitors the underlying funds.
- The fund managers of the underlying mutual funds who manage their respective portfolios.
- Broad Diversification: Offers an easy way to get exposure to a wide range of investments (equities, debt, gold, international markets, specific sectors, etc.) without having to individually select and manage multiple funds.
- Professional Expertise: You benefit from the expertise of not just the FoF manager but also the managers of all the underlying funds.
- Simplification: Simplifies investing for individuals who may lack the time, expertise, or desire to research, select, and rebalance multiple individual funds themselves.
Types of Funds of Funds (Common in India):
- Multi-Asset FoFs: These invest in underlying funds that span various asset classes like equity, debt, and gold, providing broad diversification.
- International FoFs: These invest in mutual funds or ETFs that focus on overseas markets, allowing Indian investors to gain global exposure.
- Gold FoFs: Instead of directly investing in physical gold or gold ETFs, these invest in underlying Gold ETFs. This can be simpler for investors who don’t have a demat account required for direct ETF investment.
- Passive FoFs: These invest in underlying Index Funds or ETFs, aiming to mimic the performance of specific market indices.
- Target-Date Funds: While not always explicitly called FoFs, many target-date retirement funds operate as FoFs, investing in a mix of underlying equity and debt funds that automatically rebalance to become more conservative as the target retirement date approaches.
Advantages:
- Enhanced Diversification: Provides diversification across multiple funds, asset classes, and investment styles through a single investment.
- Convenience and Simplicity: Automates the diversification and rebalancing process, reducing the effort for individual investors.
- Access to Expertise: Benefits from the selection skills of the FoF manager and the management expertise of the underlying funds.
- Access to Niche Strategies: Can provide access to specialized funds or strategies that might be difficult or require large capital for individual investors to access directly.
- Disciplined Asset Allocation: For asset allocation FoFs, it ensures disciplined rebalancing as per the fund’s mandate.
Disadvantages:
- Higher Expense Ratios (Layered Fees): This is the biggest drawback. Investors pay fees for the management of the FoF itself, plus the fees charged by all the underlying funds it invests in. This “double layer” of fees can significantly eat into overall returns.
- No Control: Investors have no direct say in the selection of the underlying funds or their asset allocation within the FoF; it’s entirely up to the FoF manager.
- Potential for Over-Diversification: While diversification is good, investing in too many underlying funds might lead to diluted returns and tracking errors.
- Tax Efficiency (Important in India): As per current Indian tax laws (SEBI categorization), most Funds of Funds are typically taxed as debt funds, regardless of whether they invest primarily in equity funds. This means:
- Short-Term Capital Gains (STCG) are taxed as per your income slab if held for less than 3 years.
- Long-Term Capital Gains (LTCG) are taxed at 20% with indexation benefit if held for more than 3 years. This can be less tax-efficient than direct equity mutual funds for long-term equity exposure.
Who should consider Funds of Funds?
- Beginner investors who want diversification and professional management but are overwhelmed by choosing multiple individual funds.
- Investors seeking exposure to international markets or commodities in a simplified manner.
- Those who prefer a completely hands-off approach to their portfolio management.
- Investors prioritizing convenience and broad diversification over minimizing expense ratios and active fund selection.
However, due to the higher expense ratios and specific tax treatment, many experienced investors might prefer to build their own diversified portfolio of individual equity and debt funds directly to save on costs and benefit from potentially more favorable equity taxation.
You’re looking for some real-world examples of Funds of Funds (FoFs) available in the Indian market. It’s a diverse category, so you’ll find FoFs designed for various purposes.
Here are some sample Funds of Funds from the Indian market, categorized by their primary investment focus:
1. International / Overseas FoFs: These are very popular as they allow Indian investors to gain exposure to global markets and specific international indices/companies without directly investing in foreign stocks or ETFs.
- Motilal Oswal Nasdaq 100 FOF
- DSP US Flexible Equity FoF
- Franklin India Feeder – Franklin U.S. Opportunities Fund
- PGIM India Global Equity Opportunities Fund
2. Gold FoFs: These funds make it easier for investors to invest in gold without needing a demat account, as they invest in underlying Gold ETFs.
- Nippon India Gold Savings Fund (FOF)
- HDFC Gold ETF Fund of Fund
- ICICI Prudential Regular Gold Savings Fund (FOF)
3. Multi-Asset Allocation FoFs: While many direct “Multi-Asset Allocation Funds” manage their asset allocation directly, some may also be structured as FoFs, investing in other equity, debt, and gold funds.
- ICICI Prudential Asset Allocator Fund (FOF)
- Aditya Birla Sun Life Financial Planning FOF – Aggressive Plan
- Kotak Multi Asset Allocator Fund of Fund – Dynamic
4. Thematic/Sectoral FoFs (Domestic): These are less common but exist to give exposure to specific themes or sectors by investing in relevant underlying funds.
- ICICI Prudential Thematic Advantage Fund (FOF)
- ICICI Prudential Passive Strategy Fund (FOF)
Important Note: When you look at these funds, always check their “Direct Plan – Growth” option to ensure you’re getting the lowest possible expense ratio. Also, be mindful of the taxation for FoFs, which is generally like debt funds in India (STCG as per slab, LTCG with indexation after 3 years), even if they are investing in equity-oriented underlying funds. This is a crucial distinction to understand.
