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Fund of Funds

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Key Highlights

  • A Fund of Funds (FoF) is a type of investment fund that invests in other mutual funds, hedge funds, or investment funds, rather than directly in stocks, bonds, or other securities.

  • Types of Fund of Funds includes mutual fund, hedge fund, private equity and international FoFs.

What is Fund of Funds?

A Fund of Funds (FoF) is a type of investment fund that invests in other mutual funds, hedge funds, or investment funds, rather than directly in stocks, bonds, or other securities.

In simple terms, instead of picking individual investments, a Fund of Funds picks other funds to invest in aiming to offer diversification and professional management in one product.

How It Works?

  • Investors put money into a Fund of Funds.
  • The fund manager uses that money to buy units of other funds.
  • The returns to investors come from the performance of the underlying funds.

Types of Fund of Funds

1. Mutual Fund FoFs

Invest in other mutual fund schemes.

2. Hedge Fund FoFs

Common in global markets, these invest in multiple hedge funds to spread risk.

3. Private Equity FoFs

Invest in various private equity funds for broader exposure.

4. International FoFs

Indian mutual funds may offer FoFs that invest in overseas funds (e.g., US-based ETFs).

Example (India)

Suppose a Fund of Funds in India invests in 5 different mutual fund schemes:

  • 2 equity funds
  • 2 debt funds
  • 1 international fund

An investor in this FoF gets exposure to all these categories through a single investment.

Advantages of Fund of Funds

1. Diversification: Spreads investment across multiple funds and asset classes, reducing risk.

2. Professional Management: Both the FoF and the underlying funds are managed by experts.

3. Easy Access to Global or Thematic Funds: FoFs can give retail investors access to international markets or niche sectors.

4. Simplified Portfolio Management: No need to research multiple funds individually; one fund handles that.

Disadvantages of Fund of Funds

1. Double Layer of Fees: You pay fees for both the FoF and the underlying funds, which can eat into returns.

2. Overlap Risk: If multiple underlying funds hold similar stocks, diversification may be less effective than it appears.

3. Tax Treatment: In India, most FoFs are treated as debt funds for taxation, even if the underlying funds are equity-based (unless the FoF invests in only Indian equity funds).

Who Should Invest?

  • Beginner investors looking for diversification without too much research.
  • Busy professionals who want simplified portfolio exposure.
  • Investors seeking international diversification through regulated Indian funds.