Fund of Funds in India: Meaning, Types, Benefits, and Risks

Diversifying your investments is one of the golden rules of wealth building, but creating a balanced portfolio is not always simple. For new or time-strapped investors, selecting the right mix of mutual funds, monitoring their performance, and making adjustments regularly can feel like a full-time job. That’s where Fund of Funds (FoFs) come in—offering an easy and efficient way to diversify without the need to manage multiple investments yourself.

FoFs are mutual fund schemes that invest in other mutual funds, rather than directly in stocks or bonds. Let’s say you want to invest in Indian equities, debt instruments, and international stocks. Instead of selecting three different mutual funds and tracking them individually, you could invest in a single FoF that combines all these elements under one professionally managed plan. This not only simplifies your investment process but also ensures your money is spread across a wide range of assets for better risk management.

In this article, we will examine the concept of a Fund of Funds in detail, explore the various types available in India, and weigh the advantages and disadvantages. 

What Is a Fund of Funds (FoF)?

A Fund of Funds (FoF) is a type of mutual fund that invests not in stocks or bonds directly, but in a selection of other mutual fund schemes. In simpler terms, it is a mutual fund that comprises various other mutual funds. Some FoFs may also allocate resources to hedge funds or exchange-traded funds (ETFs), depending on their investment strategy.

The composition of a FoF portfolio depends on its investment objective. For example, suppose you are interested in investing across sectors such as healthcare, technology, and infrastructure, but don’t want the hassle of choosing and managing separate funds for each. A sectoral FoF can take care of this by allocating your money across top-performing sector-specific mutual funds, giving you exposure to all three areas through just one investment.

Another unique aspect of Fund of Funds is its ability to diversify across both domestic and global mutual fund schemes. This enables investors to gain international exposure and reduce portfolio concentration risk, all through a single investment. Since experienced fund managers oversee these funds, investors benefit from professional decision-making, disciplined asset allocation, and market insights, making FoFs a convenient choice for those seeking diversification without added complexity.

How Does a Fund of Funds (FoF) Work?

A Fund of Funds (FoF) works by pooling capital from investors and investing it in a variety of other mutual funds, rather than directly in stocks or bonds. This structure allows investors to gain exposure to a wide range of asset classes, such as equities, debt, or international markets, through a single investment. The FoF is managed by professional portfolio managers who strategically select the underlying mutual funds based on the investor’s risk tolerance and the fund’s investment goals.

By investing in a mix of mutual funds, a FoF offers built-in diversification, reducing the risk associated with investing in individual stocks or bonds. The fund manager monitors and rebalances the portfolio as needed, ensuring it remains aligned with the fund’s objectives, whether that is for growth, stability, or a combination of both. This makes it a hassle-free option for investors who want diversified exposure but prefer to leave the fund selection and management to the experts.

What are the Types of Fund of Funds

Here are some of the prominent types of Fund of Funds (FoFs) available in India:

• Asset Allocation Funds: These funds invest in a diversified mix of asset classes, including equities, bonds, and precious metals. By combining higher-return, riskier assets with more stable ones, asset allocation funds aim to generate strong returns while minimizing risk. The balance in the portfolio allows for optimal growth with reduced volatility.
• Gold Funds: These FoFs focus primarily on gold-related assets, investing in mutual funds or companies that trade in gold securities. The aim is to provide investors with exposure to the gold market, offering diversification and protection against inflation.
• International Fund of Funds: As the name suggests, these funds invest in mutual funds or assets based in foreign markets. This type of FoF enables investors to access the global market and benefit from high-performing stocks and bonds across various countries, offering the potential for higher returns.
• Multi-Manager Fund of Funds: One of the most common types of FoF, multi-manager funds invest in a variety of mutual funds managed by different portfolio managers. Each manager focuses on a distinct asset class or investment strategy, adding layers of expertise and diversity to the fund’s portfolio.
• ETF Fund of Funds: This type of Fund of Funds (FoF) invests in Exchange-Traded Funds (ETFs) rather than directly in stocks or bonds. Since ETFs trade like stocks, they tend to be more volatile but offer greater flexibility. Investing through an ETF FoF offers accessibility without the need for a Demat account, making it easier for investors to gain exposure to ETFs with less complexity.

Advantages and Disadvantages of FoFs

Here is a differential table highlighting the advantages and disadvantages of Fund of Funds (FoFs):

Advantages of Fund of Funds (FoFs)	Disadvantages of Fund of Funds (FoFs)
Diversification: FoFs provide easy diversification by investing in a mix of mutual funds, reducing risk across various asset classes.	Additional Costs: FoFs typically have higher fees due to the management fees of both the fund of funds and the underlying mutual funds.
Easy Global Exposure: International FoFs offer exposure to foreign markets, enabling global diversification without the need to select foreign funds individually.	Double Layer of Fees: Investors pay fees both for the FoF itself and the mutual funds it holds, which can impact overall returns.
Access to a Variety of Funds: Investors can access multiple funds through a single investment, gaining exposure to different sectors or regions.	Limited Control: Investors have no control over the selection of underlying mutual funds and rely on the manager’s decisions.
Lower Liquidity: FoFs may not be as liquid as investing directly in individual mutual funds, especially if they hold less liquid assets.	Risk of Over-Diversification: A FoF can become too diversified, potentially diluting returns if the portfolio contains too many low-performing funds.
Convenience: FoFs simplify the investment process by offering one-stop solutions for diversification across multiple mutual funds.	Lower Liquidity: FoFs might not be as liquid as investing directly in individual mutual funds, especially if they hold less-liquid assets.
Rebalancing: Fund managers actively manage and rebalance the portfolio to meet the fund’s objectives, making it hassle-free for investors.	Performance Drag: While FoFs offer diversification, they may underperform individual funds if not selected correctly or if the underlying funds are underperforming.

Important Factors for Investors to Consider

Before deciding to invest in a Fund of Funds (FoF), there are several critical factors that investors should carefully assess:

• Higher Management Fees: One of the primary considerations when investing in a Fund of Funds is its higher management fees. Since FoFs invest in other mutual funds, you essentially pay for the management of both the FoF itself and the underlying funds it holds.
• These double-layered fees can reduce the overall returns on your investment. It is essential to understand the fee structure upfront and determine whether the potential returns justify these costs.
• Tax Implications: The tax treatment of FoFs can be complex, particularly when the underlying funds invest in diverse asset classes or international markets. The gains from FoFs may be subject to capital gains tax, depending on the type of fund and the holding period. Tax-efficient investment strategies should be considered to ensure tax liabilities do not overburden you.
• Potential Lower Returns: Due to the combination of management fees and tax considerations, the actual returns on your investment in a Fund of Funds might be lower than what you expect. While FoFs offer diversification and professional management, these factors could lead to a drag on overall performance. It’s crucial to assess whether the level of diversification and professional management is worth the trade-off in returns.
• Alignment with Investment Goals: As with any investment, you need to ensure that a Fund of Funds aligns with your overall financial goals. Whether you’re seeking high returns, stability, or diversification, a FoF should match your risk tolerance and investment objectives. The fund’s focus on diversification and professional management may not always align with every investor’s needs, so it is vital to evaluate whether this approach complements your strategy.

Taking these factors into account will help ensure that you make an informed decision when considering an investment in a Fund of Funds.

In conclusion, a fund of Funds can be a wise choice for Indian investors looking for diversification, simplified portfolio management, and global exposure—all bundled in one scheme. While the double-layer cost and tax inefficiency are concerns, they are manageable if you choose the right FoF aligned with your financial goals.

Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as a recommendation or investment advice by Equentis – Research & Ranking. We will not be liable for any losses that may occur. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL & the certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

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