Fund of Funds (FOF) - Meaning, Types and How to Invest

As an investor today, you get to choose from lots of options. However, choosing the right approach can be tricky. If you want a balance of professional management, easy diversification, and access to a range of mutual funds, exploring fund of funds (FOF) in India might be the right step.

Read on as we explore the benefits, challenges, and practical aspects of investing in FOFs, including tips on selecting the right fund in India and understanding important factors like taxation. If you’re thinking of a way to simplify your investment, this article will help you make the right choice.

What are Fund of Funds(FOF)?

A fund of funds (FOF) is an investment that, instead of holding stocks or bonds, invests in other funds. The FOF scheme stands out because it doesn’t invest directly in stocks, bonds, or other assets. Instead, it builds a portfolio of various mutual funds. This “multi-manager” approach allows investors to access a diversified pool of funds, potentially lowering risk by spreading investments across multiple assets and fund types.

A FOF mutual fund often invests in different mutual fund units, sometimes from various fund houses. This structure can be ideal for investors in India who prefer professional management and risk reduction without the need to choose individual stocks. Additionally, FOFs cater to those who want exposure to multiple assets or may not have the expertise to pick single fund manager.

In India, FOFs are classified for tax purposes as either “equity-oriented” or “non-equity-oriented” based on the percentage invested in equity funds. This tax distinction can impact returns, so it is crucial to understand the structure when choosing the best fund of funds in India to match your goals.

How Fund of Funds Operates

To understand what FOF is in mutual fund terms, it helps to know that this type of fund pools money from investors to buy units of other mutual funds instead of directly investing in stocks or bonds. The aim of fund of funds mutual funds is to create a diversified portfolio by selecting funds that align with investors' risk profiles, goals, and desired returns.

The fund manager actively selects and allocates these underlying mutual funds. This choice may be within the same fund house or from multiple fund houses, depending on what offers the best balance of risk and reward.

An example of this selection process is when the manager evaluates funds based on past performance, volatility, and management quality before including them in the FOF’s portfolio.

The FOF’s active management means that the manager frequently adjusts the portfolio in response to market changes. For instance, in a market downturn, the manager may shift some assets from high-risk funds to more stable funds to protect the returns.

However, this hands-on approach comes with higher fees due to separate charges for each underlying fund, impacting the FOF’s overall returns. To make the most of a fund of funds scheme, you have to review both the underlying fund fees and the FOF’s own charges as disclosed in its prospectus.

Types of Fund of Funds: Which One Fits Your Strategy?

A FOF scheme has many options to match different goals. Let’s break down some common types so that you can pick the best fit for what you need.

1. Multi-Asset Funds

These FOFs, like the Quant Multi Asset Fund and UTI-Multi Asset Allocation Fund, spread investments across asset classes like equity, debt, and commodities (e.g., gold). For example, a fund might invest in one mutual fund for stocks, another for bonds, and a third for gold. This approach offers broad diversification and reduces risk by balancing volatile and stable investments.

2. ETF-Based FOFs

These FOFs invest in a basket of ETFs (Exchange-Traded Funds), which track broad market indices like NIFTY 50. This means your investment spreads across multiple ETFs, covering various sectors. However, keep in mind that investing in ETFs typically requires a Demat account, which is where Rupeezy comes in. Example includes HDFC Gold ETF FoF

3. International FOFs

This fund of funds scheme invests in overseas funds, letting you diversify globally. For example, an international FOF might include funds that focus on top-performing foreign markets, giving you access to stocks and bonds in other countries. Examples include Axis Global Equity Alpha FoF and Bandhan US Equity FoF.

4. Gold FOFs

If you want to invest in gold but lack a Demat account, gold FOFs are a solid option. They invest in gold ETFs that hold 99.5% pure gold, providing an easy way to add gold to your portfolio. Examples are UTI Gold ETF FoF and Tata Gold ETF Fund of Fund.

Best Fund of Funds in India

Here are some of the best fund of funds in India, showing their returns and expense ratio. This will help you pick the right fund of funds in India based on your goals.

Advantages and Disadvantages of Fund of Funds

When considering fund of funds investments, it’s essential to carefully weigh the benefits and drawbacks to make an informed decision.

Advantages of FOF Mutual Funds

• Diversification: One major benefit of FOF mutual funds is diversification. These funds invest in multiple underlying funds, spreading risk across asset classes like equities, debt, and gold. This can help reduce the impact of any single asset underperforming. For example, if an equity fund struggles, other funds in the FOF may perform better, balancing overall returns.

• Expert Management: A fund of funds gives you access to professional management. Fund managers often research and select quality funds with higher expertise than individual investors can access. This hands-off approach is especially useful for beginners who may not have time or experience to manage investments.

• Easy Access to Global Markets and Gold: Funds of fund schemes make it simple to invest in global companies and gold. With international FOFs, you can access multinational stocks without opening separate accounts. Similarly, gold funds let you invest in paperless gold effortlessly, offering diversification and ease without extra steps.

Disadvantages of FOF Mutual Funds

• Higher Fees: FOF mutual funds come with higher costs. You pay fees for the FOF itself as well as the underlying funds. These fees can significantly reduce your returns over time. Investors can end up paying management fees of up to 2% of the asset.

• Diluted Returns: The diversification that comes with fund of funds can sometimes lead to diluted returns. By spreading investments across multiple funds, low performers may offset high performers. This means you might not earn as much as you would by investing directly in high-performing assets.

• Tax Complexity: Since fund of funds involve multiple layers, you may face more complex tax situations. Gains could be subject to higher short-term capital gains taxes, especially if the fund manager frequently trades to maximize returns.

Who Should Consider Investing in a Fund of Funds?

If you're looking for diversification but have limited time or experience to manage investments, a FOF could be ideal for you. It’s especially beneficial for beginners or investors with smaller assets who want professional management. For example, a FOF mutual fund allows you to invest across various asset classes without needing deep knowledge. Fund of funds India options can give you the diversification and expertise that were once reserved for wealthy investors.

How to Select the Right Fund of Funds

When choosing a fund of funds, first assess your risk tolerance. If you're comfortable with higher risk, look for funds that invest in equity-heavy assets. Next, review the past performance of the FOF and its underlying funds to ensure they align with your goals. Fees are another critical factor; high fees can eat into your returns, so always check the expense ratio. To find the best fund of funds in India, you have to compare multiple options to match your financial objectives.

How to Invest in Fund of Funds

Investing in a fund of funds (FOF) in India is simple. Here’s how to:

1. Research FOFs: First, understand the FOF in full form and choose one that suits your financial goals, risk tolerance, and investment horizon.

2. Select the fund: Once you’ve found a suitable fund, check its past performance, underlying investments, and fee structure.

3. Create an account: If you're using Rupeezy, sign in on the platform, which is designed for easy investment in FOFs.

4. Deposit and invest in FOF: Choose the fund of funds scheme you want to invest in, deposit money into your preferred fund house using UPI and Netbanking, and complete the transaction.

Rupeezy makes it easy, affordable, and hassle-free to start investing in fund of funds in India. It offers an intuitive platform to manage your investments with ease.

Conclusion

A fund of funds offers you diversification, professional management, and a way to invest in multiple mutual funds through a single scheme. If you're looking for a simple way to spread risk and access various investment strategies, a FOF could be a great choice.

Before investing, consider factors like fees, past performance, and your risk tolerance. If you're ready to get started, check out the best fund of funds in India on Rupeezy. Explore your options today and invest with confidence.