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What are Fund of Funds (FOF)?

What are Fund of Funds (FOF)?

Published on 14 December 2021 .Views 0 .Comments 0
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1. Introduction:

A few investors tend to be more risk averse but at the same time expect regular returns, for these investors a fund of funds provides a good opportunity. In this article we learn more about what is a fund of funds.

2. Meaning of Funds Of Funds:


A Fund of Funds, also known as 'Multi-Manager Investment' is a mutual fund whose underlying assets are other mutual funds rather than direct investments in individual stocks, bonds and other securities. Fund of funds allows an investor to diversify his risk a bit more without significant reduction on his returns.

Conceptually, it does what you as a retail investor would do; create a portfolio which contains several funds. The difference being, when you buy funds yourself, you buy them individually and hold and track them separately, while when you buy a fund of funds, you hold just one fund which in turn holds other mutual funds.

Example:

Quantum Equity FoF Fund (Growth) – Direct Plan:

Expense Ratio: 0.51% (Over & above individual fund’s expense ratio)

5 Year Returns: 17.3% p.a.

Last three year return: 10.5% p.a.

Exit Load: 1.5% for redemption within 365 days

Portfolio (Nov 2018):

One common thing all FoF Funds share is their emphasis on diversification to reduce risk without significantly affecting the returns. Fund of funds can act as alternate to your mutual fund distributor as they help you maintain asset allocation as well as hold a portfolio of Mutual Funds with minimal effort. But an Investor must always have a look at both the sides of story before getting impressed.

3. Advantages of Investing in Funds of Funds:

a. Highest Diversification: Funds of Funds provide the highest level of diversification. By investing in different mutual funds not necessarily from same Fund house, a FoF gives diversification not just from type of assets but also fund manager risk, fund house risk, etc.

b. Experts to select Funds: Expert fund managers select the funds for you with the sole objective to maximize Return/Risk ratio.

c. Cost effective Asset allocation: Fund houses do not have to pay taxes for switching the money among funds to rebalance the portfolio. If you rebalance your portfolio yourself, you are liable to pay capital gains tax.

d. Less tracking: Easy tracking of your overall portfolio, just buy and keep a track of one fund. There is no need to track different funds.

e. Access to Institutional plans: These funds help you to invest in Institutional plans of mutual funds in which you cannot invest directly or there is a high entry barrier.

4. Disadvantages of Investing in Funds To Funds:

a. Extra Fees: Major drawback is that FoF charges their own fees in addition to expense ratio of the funds they buy. Suppose average expense ratio of 5 funds in the portfolio is 1.2% and the expense ratio of FoF is 0.7% then you take a hit of total 1.9%.

b. Tracking of holdings can be difficult: Since each FoF holds 3-7 different mutual funds, tracking of individual stock holding with you can be a tedious task.

c. Debt fund like Taxation: All FoFs must follow Debt Funds like taxation even though they invest primarily in Equity schemes. As we know, equity schemes are more tax efficient and therefore this becomes their biggest disadvantage.

d. Limited Options: Most of the existing FoFs only invest in their own Fund house’s fund scheme, which hampers diversification and limits the choice of selection of Funds. There are very few which invest in other Fund house’s schemes as well, such as Quantum Equity FoF Fund, Aditya Birla Sun Life Asset Allocator Multi-Manager FoF, Birla Sun Life Financial Planning Fund FoF etc

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