Not all mutual funds invest directly in stocks, bonds, or commodities. Some take a different route by investing in other mutual funds. These are called Fund of Funds or FoFs. While they fall under the mutual fund umbrella, their structure, cost, and investment approach differ significantly. But what sets them apart from regular mutual funds? Let’s decode that.
Understanding the Basics of FoFs
A Fund of Funds is a mutual fund that invests in a portfolio of other mutual funds, rather than directly buying equities, debt, or other instruments. Think of it as a single package that combines investments from several mutual funds under one umbrella. This model gives investors a packaged solution for diversification and professional allocation without the need to track multiple funds individually.
FoFs can be domestic or international in nature. Some invest only in equity mutual funds, others in debt, hybrids, or even ETFs. For instance, global FoFs route investments into overseas mutual fund schemes, offering international diversification.
Many of these underlying funds are managed by different mutual fund AMCs, which brings added variety and professional management styles into a single investment.
Common Use Cases of FoFs
Fund of Funds serve as an ideal option for investors seeking diversified exposure, especially when lacking the expertise to select individual funds. Some of its use cases are:
- Asset Allocation Funds: These combine equity, debt, and gold funds to offer dynamic allocation strategies.
- Global FoFs: These invest in international funds, giving Indian investors access to markets like the US, Europe, or emerging economies.
- ETF-Based FoFs: These allow retail investors to invest in ETFs through SIPs or lump sum without a demat account.
- Thematic or Sectoral FoFs: These track niche investment themes through a basket of funds aligned with sectors like technology, infrastructure, or clean energy.
Key Differences: FoFs vs Regular Mutual Funds
Understanding how Fund of Funds differ from conventional mutual funds is essential before investing. Though both offer diversification, their structure, cost, and operational mechanics set them apart.
Single vs Multi-Layered Structure
Traditional mutual funds invest directly in assets like stocks, bonds, or gold. Since FoFs invest in other funds, there’s an extra layer between your money and the market, which can sometimes delay how quickly market changes affect your investment. It also complicates NAV calculation, as it depends on the underlying schemes’ performance and timing.
Cost Implications and Expense Ratios
FoFs tend to have higher costs. This is due to the dual expense ratio; the investor pays fees for both the FoF and the underlying schemes. While the Securities and Exchange Board of India (SEBI) caps the Total Expense Ratio (TER) for FoFs at 2.25% (excluding GST), the overall effective cost can be higher compared to direct mutual funds. In contrast, regular equity or debt funds typically have a single-layered TER, which is easier to assess and track.
Liquidity and Exit Load Factors
FoFs generally have lower liquidity than standard mutual funds. Redemption may be delayed if the underlying funds follow non-daily NAV cycles or are offshore funds. Also, some FoFs apply separate exit loads, apart from what is charged by the underlying funds. This makes timing exits slightly more complex, especially during market stress or when switching across funds.
When selecting a FoF, it’s important to evaluate the performance track record of the underlying schemes, the fund manager’s asset allocation strategy, and the cumulative cost structure. FoFs work best when aligned with long-term financial goals and risk appetite.
Conclusion
Fund of Funds offers a unique middle ground between diversification and simplicity. Their multi-layered structure and higher cost make it crucial to assess before investing. For the right investor who is seeking ease, diversification, and professional fund selection, FoFs can be a suitable choice. However, always evaluate the entire fee structure and ensure it aligns with your financial objectives for long-term wealth creation.
