The world of mutual funds has expanded significantly over the years, offering investors more flexibility, access and choice. One category that has gained increasing attention is Fund of Funds, often referred to as FoFs. These are mutual fund schemes that invest in other funds rather than directly in shares, bonds or other securities. For investors who want diversification, professional management and the convenience of a single point of investment, FoFs can be an attractive option.
This guide explains what Fund of Funds are, how they work, their benefits, risks and things to consider before investing in them.
What Are Fund of Funds?
When you invest in a Fund of Funds, you invest in a mutual fund scheme that builds its portfolio by investing in other mutual fund schemes. Instead of selecting individual securities such as stocks or bonds, the fund manager selects and manages a portfolio of underlying funds. These can include equity funds, debt funds, hybrid funds, international funds or even a mix of all three, depending on the fund’s objective.
This makes FoFs different from conventional mutual funds, which hold individual securities. FoFs provide a layered approach to diversification and are often designed to simplify the investment experience.
How Do Fund of Funds Work?
Fund of Funds follow a structured process:
- The investor buys units of the FoF scheme.
- The FoF collects funds from multiple investors.
- The FoF invests this money in a selection of underlying mutual funds.
- The performance of the FoF depends on how the underlying funds perform.
- The fund manager actively monitors and rebalances allocations when needed.
FoFs may invest in funds managed by the same AMC or across different AMCs, depending on the scheme’s strategy.
Types of Fund of Funds
FoFs come in various categories to suit different goals and risk appetites. Some of the common types include:
Domestic Equity FoFs
These invest in equity-oriented mutual funds within the domestic market. They allow investors to gain exposure to multiple equity strategies through a single investment.
Debt FoFs
These focus on investing in debt or fixed-income mutual funds. They aim for potentially stable returns and lower volatility, making them suitable for conservative investors.
Asset Allocation FoFs
These invest in a mix of equity, debt and sometimes gold funds. The asset allocation may be static or dynamically adjusted based on market conditions. They are useful for investors who want a balanced approach without managing allocation themselves.
International FoFs
These invest in overseas mutual funds, giving Indian investors access to global markets. They can offer exposure to international equities, global themes or foreign fixed-income markets without the complexities of direct international investing.
Thematic or Sector-Based FoFs
These FoFs focus on specific strategies such as emerging markets, technology, commodities or ESG-driven funds. They are suitable for more informed investors with an interest in particular sectors or global themes.
Why Investors Consider Fund of Funds?
There are several reasons why FoFs attract interest:
1. Easy Diversification
Since FoFs invest in multiple funds, they offer instant diversification across asset classes and investment strategies. This helps reduce concentration risk and can balance the overall portfolio.
2. Access to International Markets
For many investors, direct international investing can be complex due to currency rules, taxation and platform limitations. International FoFs simplify this by allowing investment through a familiar mutual fund structure.
3. Convenience
FoFs combine several funds into one, making them easier to manage. Investors do not need to analyse multiple individual funds or handle periodic rebalancing, as the fund manager does this.
4. Professional Allocation
Choosing the right combination of funds requires expertise. With FoFs, experienced managers handle fund selection and allocation, which can be helpful for new or busy investors.
5. Flexibility
FoFs come in various categories, allowing investors to select options that match their goals, risk profile or interest in specific markets.
Risks and Considerations Before Investing
Although FoFs offer several advantages, they also come with certain risks and factors that investors should be aware of.
1. Double Layer of Fees
FoFs may incur two levels of expenses. The first is the expense ratio of the FoF itself, and the second is the expense ratio of the underlying funds. This means overall costs may be slightly higher compared to other mutual funds.
2. Market Risk
Since FoFs invest in mutual funds, their performance is linked to the markets that the underlying funds invest in. Equity FoFs face equity market volatility, while debt FoFs face interest rate and credit risks.
3. Taxation
Tax treatment for FoFs depends on the type of underlying funds. In many cases, FoFs are taxed as debt funds, even if the underlying allocation includes equity. Investors should check the specific tax rules before investing.
4. Over Diversification
Too much diversification may sometimes lead to average rather than exceptional performance. Since FoFs invest in many funds, the effect of high-performing funds may get diluted.
5. Currency Risk in International FoFs
International FoFs carry exposure to foreign currencies. Fluctuations in exchange rates may influence returns, both positively and negatively.
Understanding these factors can help investors make more informed decisions and choose FoFs that match their goals.
How to Invest in a Fund of Funds?
Investing in FoFs is straightforward and similar to investing in other mutual fund categories. The basic steps include:
- Define your investment goal, such as diversification, global exposure or balanced allocation.
- Review the FoF categories available and shortlist schemes that match your objective.
- Check the investment objective, underlying fund composition, past performance trends and risk rating.
- Evaluate costs, especially the total expense ratio, since FoFs have layered fees.
- Choose whether to invest via a lumpsum or a systematic investment plan (SIP).
- Complete KYC if needed and invest through online platforms or mutual fund distributors.
Who Should Consider Investing in FoFs?
FoFs can be suited for:
- New investors who want diversification without complicated decision-making
- Investors looking for global exposure in a simple format
- Individuals seeking managed asset allocation strategies
- Those who prefer convenience and professional oversight
They may be less suitable for investors who want full control over their fund selection or who are sensitive to expense ratios.
Final Thoughts
Fund of Funds provides an accessible way to diversify, explore global markets and benefit from active allocation without the need to pick individual funds. Like any investment, they carry risks and costs that should be considered carefully. However, for many investors seeking convenience and broad market exposure, FoFs can be a useful addition to a well-constructed financial plan.
