What is Fund of Funds? What are its Types? Should You Invest?

In this article, we will be discussing Fund of Funds (FOFs) which are a common type of mutual funds available in the market. So let’s discuss what is it, what are its types, what are its pros & cons, and what are its taxation criteria.

What are Funds of Funds?

• A fund of funds (FOF) is a pooled fund that invests in other funds.  This type of investing is often referred to as a multi-manager investment.
• FOFs usually invest in other mutual funds or ETFs. So its portfolio contains different underlying portfolios of other funds
• The fund of funds strategy aims to achieve broad diversification and minimal risk
• Given SEBI’s restrictions on overseas investment for mutual funds, investing in foreign ETFs has emerged as an alternative route
• They can invest in asset class-based mutual funds including, equity, debt, and commodities

Types of FoF:

There are 5 types of FOFs available in the market, they are as follows:

1) Plain FOFs:

• These funds invest in a single fund – be it a mutual fund, index fund, or ETF.
• Some of the examples of plain FOFs are:

2) Asset Allocation FOFs:

• These funds invest in asset allocation funds which give exposure to equity, debt, and commodities.
• Examples – ABSL Asset Allocator FoF, Franklin India Dynamic Asset Allocation FoF, HDFC Asset Allocator FoF, HDFC Dynamic PE Ratio FoF, ICICI Pru Asset Allocator FoF
• Portfolio and Asset Allocation of ABSL Allocator FOF are as follows:

3) Commodity FOFs:

• These funds invest in commodity ETFs
• Examples –  ABSL Silver ETF FoF, ICICI Pru Regular Gold Savings FoF, Edelweiss Gold & Silver ETF FoF.

4) International FOFs:

• This fund invests in international equity mutual funds or FoFs.
• Some of the examples of international FOFs are:

5) Multi-Manag er FOF:

• A multi-manager fund of funds usually has multiple portfolio managers
• Example of Multi-Manager FOF are:

Taxation Structure:

Fund of Funds attracts consists of the following taxation criteria depending upon the following conditions:

i) More than 90% in domestic equity securities:

• If an FoF invests more than 90% in domestic equity securities, then it gets the tax benefit of a regular equity MF scheme. So, short-term capital gains (STCG) will be taxed at 15% if the FoF units are sold within one year.
• For units sold after one year, long-term capital gains (LTCG) will be taxed at 10% if profits exceed Rs. 1 lakh a year.

ii) Less than 90% in domestic equity securities

• Equity-oriented FoFs with less than 90% exposure in domestic stocks are taxed like a debt fund.
• This means, in this case, STCG will be based on the investor’s income tax slab if he/she sells the FoF units within 3 years
• LTCG gains will attract 20% taxation with indexation benefit when these FoF units are sold after three years.

Positives & Negatives:

Positives:

• Diversification
• Professional Management Expertise
• Lower risk & volatility
• Better suitable for smaller investors
• Accessible investments

Negatives:

• High expense ratio
• Risk of overlap in holdings

What Should Investors Do?

FOFs mutual funds are the funds that invest in other mutual funds and hence involve the risk of the higher expense ratio and holdings overlapping, but these funds can be a good option for those investors who are not willing to take many risks and seeks asset allocation diversification. Therefore, an investor can assess this counter but should follow due diligence before making any investment decisions.

Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.