Fund of Fund Explained: Top 2022 Benefits of Investing in Fund of Funds
Fund of funds provides unique solutions for investor needs
Many investors prefer to invest in multiple assets for diversification. However, they prefer to do this through a single mutual fund scheme rather than multiple financial products. Many investors also prefer to invest in gold through mutual funds rather than coins, gold ETFs, etc as gold mutual funds provide SIP option. For all these categories of investors, a fund of fund (FoF) is the solution. In this article, we will understand the fund of funds and the benefits of investing in them. Let us get started with the fund of fund meaning.
Introduction to fund of funds
A fund of funds (FoF) is a mutual fund scheme that collects money from its investors and invests in the units of other mutual fund schemes. So, rather than investing money directly in an asset class such as equity shares of a company or physical gold, it invests money in the units of another mutual fund scheme that directly invests in these securities.
For a fund of fund mutual fund, the choice of fund/s (single or multiple) for investment depends on its investment objective. For example, a gold fund of funds like HDFC Gold Fund invests in the units of HDFC Gold ETF only. In comparison, an equity FoF like Quantum Equity Fund of Funds has invested in units of nine different equity funds (as of November 2021). The FoF fund manager may choose to invest in the mutual fund units of the same AMC or across mutual fund units of different AMCs.
Who should invest in a fund of funds?
Like most other mutual fund schemes, a fund of fund's main objective is to generate maximum returns for its investors. However, fund of funds caters to the investment needs of specific investors. Investors looking for the following benefits should invest in a fund of funds:
Investors looking for diversification into multiple equity mutual funds through a single mutual fund scheme should invest in a fund of funds. Also, investors looking for diversification into multiple asset classes such as equity and debt or domestic equity and international equity through a single mutual fund scheme should invest in an FoF.
Investment in international equities
For investing in international equities, most fund managers of Indian international equity schemes invest in units of international equity schemes. The international equity schemes, in turn, invest directly in equity shares of international companies. So, investors who want exposure to international equities should invest in a fund of funds that invest in units of international equity schemes.
Types of fund of funds
There are various types of fund of funds. Some of these include:
Asset allocation funds
An asset allocation FoF gives investors exposure to multiple asset classes through a single scheme. For example, the Franklin India Dynamic Asset Allocation Fund of Funds invests in equity and debt asset classes. The scheme invests in various inhouse equity and debt schemes of Franklin Templeton Mutual Fund. The ratio of equity and debt is managed dynamically based on the price to earnings (PE) and price to book (PB) ratios of the Nifty 500 Index.
A gold fund primarily invests in the units of an inhouse Gold Exchange Traded Fund (ETF). For example, the Axis Gold Fund invests in the units of Axis Gold ETF. The gold ETF, in turn, invests in physical gold. Gold FoFs are suitable for investors who want to invest a certain portion of their portfolio in gold as part of an asset allocation strategy. Some examples of gold funds in India include:
- Aditya Birla Sun Life Gold Fund
- IDBI Gold Fund
- Invesco India Gold Fund
- Kotak Gold Fund etc.
International fund of funds (FoFs)
As discussed earlier, an international FoF invests in the units of an international mutual fund scheme that, in turn, invests in various financial securities (equity, fixed income, gold, real estate, etc.) at an international level. Some examples of international fund of funds include:
- Invesco India – Invesco Global Consumer Trends Fund of Fund, which invests in the units of Invesco Global Consumer Trends Fund (an international fund)
- IDFC US Equity Fund of Fund, which invests in units of JP Morgan US Growth Fund
- Sundaram Global Brand Fund, which invests in units of Sundaram Global Brand Fund, Singapore
Multi-manager fund of funds (FoFs)
A multi-manager FoF invests in units of various other mutual fund schemes that are expected to do well based on the research team’s analysis. Some examples of multi-manager FoFs include:
- IDFC Asset Allocation Fund of Funds Aggressive Plan that invests units of other IDFC mutual fund schemes (equity and debt funds)
- Aditya Birla Sun Life Financial Planning FoF - Aggressive Plan that majorly invests in units of equity schemes of multiple fund houses
- ICICI Prudential Thematic Advantage Fund (FoF) that invests in sectoral/thematic funds of ICICI Prudential MF (majorly) and some other AMCs
Advantages of investing in fund of funds
There are various advantages for an investor to invest in FoFs. Some of these include:
- Portfolio diversification: The major benefit of investing in a FoF for an investor is the portfolio diversification that they get. As seen above, some FoFs invest across various asset classes, some invest in a mix of domestic and international equity, some invest across various sectors/themes, and some invest across various inhouse schemes or across AMCs. All these FoFs give the investor much-needed portfolio diversification.
- Better risk-adjusted returns: As discussed above, an FoF provides diversification for an investor. A well-diversified portfolio provides better risk-adjusted returns, which most investors want.
- Portfolio rebalancing: Most FoFs manage their portfolio dynamically. It involves switching across asset classes, schemes in the same asset classes, etc. If an investor does this individually, there will be tax implications. But, when an FoF does this, there are no tax implications for an investor.
Disadvantages of investing in fund of funds
Some of the disadvantages of investing in an FoF include:
- High expense ratio: Most FoFs have a higher expense ratio than an equity mutual fund scheme. The high expense ratio eats into the returns of an investor.
- Tax treatment of a debt fund: Most FoFs are considered debt funds from the taxation point of view. It results in higher capital gains tax compared to equity funds.
Top 5 fund of funds in India
The top five fund of funds in India include:
|Scheme name||AUM (Rs. crores)||1-year||3-years||5-years|
|Franklin India Feeder – Franklin US Opportunities Fund||4214||20.35%||37.01%||24.83%|
|Edelweiss Greater China Equity Off-shore Fund||1,973||-4.88%||29.68%||21.92%|
|DSP World Mining Fund||162||18.69%||25.57%||18.06%|
|DSP US Flexible Equity Fund||681||24.92%||25.89%||17.93%|
|ICICI Prudential Thematic Advantage Fund (FoF)||130||46.09%||23.28%||17.60%|
Note: The above returns are as of 24th December 2021. The returns are for direct plans with growth option. The funds have been ranked based on 5-year returns.
Things to consider as an investor
When investing in FoFs, an investor should consider the following things:
- Multiple securities through a single FoF: Most FoFs either invest in multiple asset classes or multiple themes or multiple schemes within a single theme, etc. As an investor, you need to consider whether you want to invest in multiple securities through a single FoF. Or would you like to keep multiple securities separate by investing in them through different products rather than a single FoF?
- Taxation: Most FoFs are taxed as debt mutual fund schemes. So, the equity component of the FoF also gets taxed as a debt mutual fund scheme. As an investor, you need to consider whether you want to invest in a pure equity mutual fund scheme and get preferential tax treatment that of an equity fund. Or invest in an FoF with some equity component and pay tax on it similar to a debt mutual fund.
An FoF can give you exposure to multiple asset classes, or multiple themes, or multiple mutual fund schemes through a single product. Hence, as an investor, an FoF is a good investment product for you if you want to keep your investment portfolio simple with very few investment products.
To start investing in fund of funds (FoFs) mutual fund schemes as per your appropriate asset allocation, download the Glide Invest App from Google Play Store or Apple App Store and get started