Let us understand what is Fund of Funds. Considering the popularity of mutual funds, you should already know how mutual funds work. To give a quick recap, mutual funds are investment vehicles that pool investors’ money and then invest it in a variety of asset classes such as equities, debt and gold, and according to different investment strategies. The choice of asset class or investment strategy is based on the investment order of the particular scheme. Now when a mutual fund scheme invests in other mutual fund schemes it is called fund of fund, i.e. instead of investing directly in equity or debt securities, it invests in other funds. A FoF can invest in funds of the same fund house or he can choose to invest in funds of any other fund house.
Different types of FOF you should know about
While there are different types of FoF available in the market, here are some of the top ones you should be aware of:
- Asset Allocation Fund: These FoFs invest in other funds with the goal of investing in multiple asset classes. For example, they can invest in an equity mutual fund scheme, a debt fund scheme and a gold fund scheme. The idea is to obtain exposure to a range of asset classes which may include equities, debt, gold and other commodities.
- International Fund of Funds: These FOFs invest in international mutual fund schemes, i.e. mutual funds that invest directly in global companies or invest in global funds that can provide exposure to global companies.
- Gold Fund: The purpose of these FoFs is to uncover fluctuations in gold prices by investing in physical gold, shares of companies engaged in gold mining or even gold exchange traded funds (ETFs).
- Multi-manager fund of funds: These are FOFs that invest in other mutual fund schemes based on the managers who manage the different schemes.
Things you need to know about FoFs
Now that you know about the different types of FoF available in the Indian market, let us understand whether you should invest in FoF or not. For this, let us first know about the advantages and disadvantages of FoFs.
Benefits of FOF: How FOF can add value to your portfolio
- Easy to invest: Like in our restaurant example, where a food court makes it easy for you to consume all your favorite dishes under one roof, a FoF can give you exposure to multiple mutual fund schemes through a single investment. In addition, it also becomes easier to track, review and manage your investments as compared to many different funds.
- Ease of rebalancing: Rebalancing is an important part of managing your investment portfolio better. However, each time you rebalance your portfolio you may need to sell some investments and buy another set of investments. Selling an investment means you may have to pay capital gains tax, wherever applicable. However, when FoFs rebalance their portfolios, there is no capital gains tax on this transaction. This means that the rebalancing of the fund’s assets internally is tax-free. Thus, you can get the benefits of rebalancing without paying tax liability.
- Give small investors easy access to investments: Small investors who have limited funds may find it difficult to achieve diversification by investing in multiple mutual fund schemes. However, FoF can prove to be an ideal option for low capital investors as these investors can get access to multiple funds through a single investment.
Disadvantages of FOF: Things you need to know before investing in FOF
- High Expense Ratio: All mutual fund schemes incur some expenses attributed to the management of the fund. Since the fund manager of a FoF is managing investments in multiple funds, these funds have higher expenses as compared to other mutual fund schemes. Interestingly, the investors of the FOF have to bear the additional cost of the underlying schemes in which the FOF has invested.
- Portfolio duplication: Since FoFs invest in multiple fund schemes, there is always a possibility that some of the underlying funds or securities may already be in your investment portfolio. This leads to overlap and reduces the diversification benefits of investing in multiple schemes.
Tax Implications of FoF
In case of loan FOF and international FOF, short-term capital gains (STCG) tax is applicable as per the income tax slab of the individual investor, if the investment is redeemed within three years of purchase. Also, for investments sold after three years, a long-term capital gains (LTCG) tax of 20% with indexation is applicable. In case of equity FoF, STCG is 15% for profit made on investment sold within one year of purchase and LTCG is 10% for profit which exceeds Rs. 1,00,000 and is sold after one year of purchase .
Taxation Aspects of FoF You Must Know
Should you invest in FoF?
If you are someone who does not have a lot of money to invest but still wants to gain diversification by investing in multiple schemes, then a FoF can be a good investment option for you as through a single investment you can desired diversification can be achieved. On the other hand, if you are a seasoned investor looking to add more investments to your portfolio but don’t want the hassle of managing multiple investments, a FoF would be ideal for you as you can hedge your portfolio’s risk through a single fund. can increase. However, before investing in FOF, make sure that your portfolio does not have a high degree of overlap as is the case with other securities or investments and pay attention to the expense ratio of FOF. Like any other investment, make sure it aligns well with your risk profile and fits well with your overall asset allocation strategy. Don’t look at investing in silos. Always consider them from the perspective of your overall investment portfolio.
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Mutual fund investments are subject to market risks, read all the scheme related documents carefully.