What is Fund of Funds – Meaning funds of funds, Advantages and Taxation

Fund of Funds Meaning: What is a Fund of Funds?

As the name suggests, a Fund of Funds (FoF) is a mutual fund scheme that creates an investment portfolio comprising units of other mutual fund schemes. FoFs may also provide access to investment options that are not directly available to the investors under mutual funds without Demat accounts, like Exchange Traded Funds (ETFs). Schemes under an FoF are chosen as per their suitability to the investment objective of the FoF.

Net Assets Under Management as on September 30, 2022 under the Fund of Funds category is ₹74,365 crores, with around 74% share of such funds investing in domestic schemes while 26% FoFs are investing overseas. (Source: Association of Mutual Funds in India – AMFI)

What Is The Difference Between MF and FoF?

Mutual funds invest the pooled money from investors into a basket of securities, such as stocks, bonds, commodities, etc. On the other hand, FoFs invest the pooled money from investors into units of mutual fund schemes. These mutual fund schemes may be from the same asset management company or others too.

How Does a Fund of Funds Work?

A Fund of Funds or FoF works on a certain investment strategy whereby it invests in units of other mutual fund schemes instead of directly investing in securities, stocks or bonds. This strategy is also known as multi-manager investment. Since the investment risk is diversified thanks to the spread across multiple underlying funds, FoFs may appeal to certain investors. They may be suited to smaller investors who seek exposure to different asset classes through a single investment instrument.

FoFs may also be helpful in cases where direct investment in the fund is not convenient or simple for investors. For example, exchange traded funds (ETFs) are traded over stock exchanges and require brokerage/demat accounts. Investors who find this cumbersome may opt to invest in an ETF FoF, which invests in the units of the underlying ETF. Through this method, they don’t need to open a demat account or place an order on the stock exchange. They can directly invest in the scheme through the asset management company.

Is It Good to Invest in Fund of Funds? Advantages of Investing in Fund of Funds

The investors in Fund of Funds can benefit from the fund managers’ expertise in managing the FoF and the underlying schemes in which FoF has invested. Further, such funds also enable the investors to reap the diversification benefit across different fund categories and asset classes within one product.

FoFs may have a higher expense ratio indirectly as they bear the expense ratios of the portfolio schemes apart from their expenses. However, the advantages that FoFs bring along tend to compensate the investors suitably.

FoFs also enable investors' access to ETFs, as an investor must have a Demat account and a trading account with a stockbroker to invest in ETFs otherwise. Further, the liquidity in ETFs is not guaranteed and depends on the demand and supply of ETF units at the stock exchanges. In contrast, the investors are also assured of liquidity in FoF, as the investments happen through mutual fund houses.

How to Invest in Fund of Funds?

The process of investing in FoF is similar to investing in any other mutual fund scheme. One can submit the application forms at any official Points of Acceptance or invest online through the mutual fund’s website or mobile app. One can hold such units either in investor folios or in a Demat account and can also register a Systematic Investment Plan (SIP) to make regular investments.

Taxation of Fund of Funds

Income tax laws classify mutual funds, including FoFs, into two categories - equity-oriented funds and other than equity-oriented funds. An equity-oriented fund must invest at least 65% in equity and equity-related instruments, but the classification criteria for Fund of Funds are more stringent. FoF can be classified as an equity-oriented fund if it invests at least 90% in Exchange Traded Funds (ETFs), which further invests at least 90% in shares of Indian companies listed on stock exchanges. For taxation purposes, all other FoFs are considered 'other than equity-oriented’ schemes even if they invest 100% of their net assets in another equity fund.

Here is a summary of taxation rules for mutual fund schemes:

Disclaimer:

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

SIP (Systematic Investment Plan) is a feature offered for a disciplined investment of a certain amount on a pre-decided date in a specific mutual fund scheme, regularly over a period of time.