What are Fund of Funds?

Fund of Funds (FOF) is a type of a mutual fund scheme that invests its collected pool of money in other mutual fund schemes. Also known as a multi-manager investment, fund of funds helps in diversifying one’s investment portfolio and risk by dispersing the investment in multiple funds. These funds can be invested in debt, equity and even hedge funds.

Usually best suited for small investors, these are best for investors with a low-risk appetite who also want to invest in different asset classes.

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Here are some of the features of investing in Fund of Funds:

Diversification:

The most important benefit of investing in an FoF is the range of diversity it brings to an investor’s portfolio. These funds are professionally managed and researched and are invested in a variety of different asset classes. The funds are balanced between debt and equity to achieve the desired risk ratio.

Tax:

With the rebalancing of the debt-equity ratio, no tax is levied on the capital gains earned. However, despite investing in equity mutual funds, fund of funds are taxed just like any other debt mutual fund. If the funds are sold before completing 36 months, a Short-Term Capital Gains Tax is levied on the taxable income as per the income tax slab of the investor. The Long-Term Capital Gains are taxed at 20% with indexation.

Professional Portfolio Fund Management Services and Managers:

FoFs are managed by highly experienced, professional fund managers that are verified and background checked to ensure that you have credible fund managers who handle your investments. Proper analysis and market research are conducted by portfolio managers to ensure that the investors get high gains. You can also invest in professionally managed funds first before starting out on your own to invest individually.

Small Investors:

Fund of Funds is ideal for small investors with limited capital and a lower risk appetite. These allow investors to put their capital in multiple assets at once resulting in a more balanced portfolio.

High Expense Ratio:

The expense ratio associated with Fund of Funds is considerably higher than the standard Mutual Funds due to its higher managing expense. As these are managed by professional managers, the administrative and management fee are added in addition to the existing expenses. Despite the expense ratio for FoFs being 1%, the investor must pay this amount on every fund that is owned by the FoF.

Fund of Funds do allow excellent diversification on an investor’s portfolio; however, over-diversification can become riskier if not managed properly. Every investor needs to conduct thorough research before investing in any fund. With that, research and verification need to be conducted in terms of portfolio managers too, to ensure that you have an experienced fund manager.