A Fund of Mutual Fund or FOF is a mutual fund that invests in other units of mutual funds rather than investing directly in stocks, bonds or other investment securities. There are FOFs in India that invest specifically in foreign mutual funds or exchange traded funds (ETFs).
Types of fund schemes
i) Investing abroad
This type of fund of funds (FOF) invests in foreign funds registered abroad. As these foreign funds hold foreign stocks, an Indian investor becomes exposed to foreign stocks by investing in a mutual fund that invests in foreign currencies.
ii) Investing in ETFs
FOFs invest in Exchange Traded Funds (ETFs). An ETF invests in stocks, bonds or commodities such as gold. Unlike ordinary mutual funds, ETFs are not traded but traded continuously on stock exchanges. Investors, however, should have a demat and trading account to invest and trade in ETFs.
In addition, there are asset allocation or multi-asset funds, global mutual funds, ETF-based mutual funds, gold mutual funds, rebalancing simple funds and diversified mutual funds.
Advantages of FoF
Investing in FoF has many benefits and the risk profile of FoF is moderate. Part of the reason for this is that FoF is invested in other classes of mutual funds. So the FoF will automatically diverge. First, since mutual funds and FOFs buy their own shares and invest in equity and debt.
A FOF can buy as many mutual funds as it wants. They can diversify by sector and invest in mid-cap and large-cap two, as FoF buys into other mutual funds, it invests in debt mutual funds, equity mutual funds, gold ETFs and real estate. Mutual fund. If, over a period of time, the equity mutual fund performs well but the debt mutual fund does not, an investor in FoF may not suffer much, as the debt asset will be balanced by the leveraged asset.
FoFs are also known as multi-manager investments because these are managed by at least two fund managers – one, the fund manager of the underlying mutual fund whose units are bought by the FOF, and the other is the fund manager of the FoF itself. Therefore, an investor in FoF gets the benefit of having her funds managed by two professional fund managers.
Why should you invest in FoF when you can invest directly in mutual funds? The answer to this question is, if you are just starting to invest in mutual funds, investing in FoF will give you a good experience of all types of mutual funds rather than taking the risk of investing in one type. A mutual fund may or may not perform well.
Disadvantages of FoF
However, many mutual fund schemes that FoF offers have their own expense ratios. Since FoF has to consider the aggregate expense ratio of the underlying funds, it has a higher expense ratio. In addition, investors have to bear the recurring expenses of the respective fund scheme in addition to the underlying schemes in which the fund scheme invests.
One major disadvantage of investing in FOF is that investors cannot choose the mutual fund in which FOF invests. So, if a FoF invests in ten mutual funds, it will automatically be exposed to those ten funds.
There may also be duplication. When FoFs invest in different mutual funds, there may be a possibility that two or more mutual funds in which the FOF invests will be exposed to the same stocks or debt securities.
Paying taxes can be another disadvantage of FoFs. For tax purposes, most FOFs are treated like any debt mutual fund scheme, even if the money is invested in equity mutual fund schemes. If you withdraw your investment from FoF before three years, short-term capital gains tax is applicable as per the investor’s income tax slab. Long term capital gains tax at 20% on indexation benefits is also applicable.
However, mutual funds take away the tax implications of buying and selling units of mutual funds and the overall tax impact on the investor is minimal.
Who should invest in FOFs?
Investors who want to benefit from a variety of investments and multiple fund managers can invest in mutual funds. People with moderate appetite can invest in FOF as the fund invests a large amount in equity.
FoF is a good investment option even for a beginner, as the investor wants to know how different mutual funds work and invest directly in mutual funds and later gain confidence in equity.
How to invest?
One can invest in FoFs online or offline. Investors can invest through SIPs or lump sum investments. Alternatively, an investor can simply fill up the physical form and submit it at the nearest branch of the fund or invest through a broker.
Before investing in FoF, it is better to ensure that there are no multiple portfolios in the mutual fund that the FoF invests in or in its own portfolio. And with an overall strategy, it’s important to ensure that all of your investments are well aligned with your risk profile and aligned with your overall asset allocation strategy. Diversifying investments and balancing them with your risk profile are key to successful investments.