(FoFs), as the name suggests, are mutual fund schemes that invest in other mutual funds rather than directly purchasing stocks, bonds, or other securities. Some FoFs invest in a basket of mutual funds, while others are designed to track a single ETF, providing exposure to a specific asset class or theme.
So, let’s understand the meaning of FoFs, their types, key benefits, and limitations.
What are Fund of Funds?
Fund of Funds are a type of that does not invest directly in stocks, bonds, or other asset classes. Instead, they invest in other mutual fund schemes or just track an ETF or index fund. These funds allow you to get exposure to a diversified portfolio through a single fund.
As per SEBI regulations, FoFs are required to invest at least 95% of their assets in the underlying mutual fund schemes they are designed to track or target.
Types of Fund of Funds
Here is the list of different types of FoFs that you must know.
Domestic equity-oriented FoFs
These FoFs invest in multiple equity mutual fund schemes within India. Instead of picking individual stocks, they spread investments across different equity funds such as large-cap, mid-cap, small-cap, flexi-cap, or sectoral funds/ ETFs. This helps reduce risk through diversification while maintaining exposure to equity market growth.
There are also FoFs that invest in a single index fund or ETF that tracks a specific benchmark index.
Domestic debt-oriented FoFs
These funds invest in a mix of debt mutual fund schemes like liquid funds, corporate bond funds, and gilt funds within India. There are also debt-oriented FoFs that track a specific index fund or ETF.
These funds are generally more stable and provide lower-risk returns, compared to equity FoFs.
Domestic hybrid FoFs
Hybrid FoFs invest in a combination of equity and debt mutual funds or track a specific hybrid fund. This allows them to balance growth and stability within a single portfolio. They are suitable for investors looking for moderate risk with diversified asset exposure.
Gold funds / Silver funds
These FoFs primarily invest in or silver ETFs rather than physical metals. Additionally, these funds can be more tax-efficient than directly investing in gold or silver ETFs. You can invest or redeem FoFs without the need to open a demat and trading account.
Overseas FoFs
These funds invest in international mutual funds or ETFs, giving Indian investors exposure to global markets. They help you diversify beyond the Indian market and benefit from global growth opportunities.
How are FoFs different from ETFs?
ETFs are a type of mutual fund that directly holds a basket of securities in the same weightage as the index they track, while FoFs invest in a portfolio of different mutual funds or a single ETF instead of holding securities directly.
ETFs are passively managed, whereas FoFs are typically actively managed by the fund manager. ETFs are traded on stock exchanges throughout the day at market prices, but the NAV of a FoF is disclosed by the fund house at the end of the day.
In terms of liquidity, ETFs offer higher flexibility as they can be bought or sold at any time during market hours, while FoFs are transacted at end-of-day NAV.
ETFs usually have lower expense ratios due to passive management, whereas FoFs tend to be more expensive because of a double layer of fund expenses.
Benefits of investing in FoFs
- FoFs provide exposure to multiple mutual fund schemes through a single investment, making portfolio diversification simple and convenient for investors.
- FoFs allow investors with limited capital to invest in a diversified set of mutual funds, which would otherwise require higher investment amounts if done separately.
- A FoF that invests in a single ETF allows investors to gain exposure to the ETF without the need to open a demat and trading account. This makes investing more convenient for beginners who want to invest in a particular index, gold ETF, or international ETF.
Limitations of investing in FoFs
- FoFs have a higher expense ratio because investors indirectly pay both the FoF management fee and the fees of underlying mutual funds, which can impact net returns.
- Since FoFs invest in other mutual funds, there can be duplication of underlying holdings. This can reduce the true diversification benefit if similar assets already exist in the investor’s portfolio.
- Their performance is also heavily dependent on the selection skills of the fund manager and the performance of the underlying funds. If these funds underperform, the overall returns of the FoF will also be impacted.
Disclaimer: This is purely for educational/ informational purposes and should not be taken as any sort of investment advice. Always consult a SEBI-registered advisor before making any investment decisions.