Is it possible for a mutual fund to invest in another fund? Yes, it is totally possible through fund of funds. Fund of funds is mutual funds that invest in other mutual funds and hedge funds. Based on the investment objective, the fund pools investors’ money and invests in other funds. They invest in both domestic and international funds. Read on to find out more about how fund of funds work, their types, and how they are taxed.
Fund of funds is just like mutual funds. They pool money from investors with similar objectives and invest based on the fund’s objective. However, they don’t invest in stocks, bonds, or money market instruments. They invest in other funds by buying their units. The underlying investments are mutual funds of the same fund house or other fund houses.
The fund suits investors with different risk profiles and financial goals. They are also the most diversified funds as they invest in multiple funds.
Fund of funds suits small investors who want exposure to a diverse range of securities for a small investment. These funds invest in multiple domestic and international funds; hence are very diversified. Investors looking for diversification in their investments can consider them.
Fund of fund is also suitable for a long investment horizon. Hence investors with long-term goals who want to earn maximum returns can consider investing in them.
These funds invest in asset classes such as equities, debt securities, gold, metals, and commodities. They offer in-build diversification to investors. Investing in multiple asset classes lowers the risk of one particular asset in the portfolio. The other asset classes negate the underperformance of one asset class. Hence, these funds mostly suit investors with low-risk tolerance levels. Asset allocation funds can also give better returns due to exposure to multiple asset classes. Investors looking for good returns with low risk can invest in them.
Gold funds are open-ended mutual funds that directly or indirectly invest in gold. Fund managers either invest in physical gold or stocks of gold mining companies. They are much better than investing in physical gold as there is no loss due to theft or loss in value. Moreover, you will not have to pay GST when you invest in gold funds, which is not the case when you buy gold jewellery.
These suit investors who want to diversify their portfolio to a different asset class, such as gold. Gold funds can be used as a hedge against stock market volatility and inflation. Despite the short-term dips, or spikes, gold has been a go-to asset for Indian households. Over the years, the value of gold has grown steadily in the long term. They are ideal for long-term goals and investors who want to generate good returns over the long term.
These funds invest in international funds. International funds invest in stocks and securities of global companies. They give exposure to foreign securities and help in geographically diversifying a portfolio. Investing in these funds can also get exposure to other currencies. By investing in rupees, you can get exposure to multiple currencies and benefit from currency depreciation.
A multi-manager fund consists of many professionally managed funds. The fund of funds is overseen by one fund manager, who might offer investment advice to multiple fund managers. Alternatively, the fund manager can hire different fund managers to manage a portion of the fund.
A fund of funds that has exchange-traded funds (ETFs) in a portfolio is an ETF fund of funds. Investing in this fund is more accessible than investing in an ETF. This is because you don’t need a demat account to invest in an ETF fund of funds. Nevertheless, these funds can be risky as they are more susceptible to market volatility.
Before investing in a fund of fund, you will have to consider the following parameters:
Liquidity: Fund of funds are best for long-term goals and operate in the long term. Hence, they are less liquid in nature. It is best if investors with short-term goals stay away from them.
Risk: Though these funds have a diversified portfolio and lower risk than other funds, they are subject to market volatility. Their portfolio fluctuates based on market movements. Hence it is always better to consider this before investing in them.
Expense ratio: It is the fees the asset management charges from the investors is the expense ratio. The fund’s net asset value (NAV) is calculated after deducting the expenses. A high expense ratio indicates lesser profits for investors. Hence it is better to invest in funds with a low expense ratio.
Performance: Though the fund’s historical performance doesn’t guarantee returns, it does indicate its performance. It is always better to check a fund’s performance and compare it with a benchmark and its peers. A fund that is consistently performing better than its peers and benchmark is a good investment option.
Diversification: Fund of funds offer in-built diversification. They invest in multiple funds that invest in different securities and asset classes, automatically lowering the risk of investment.
Professionally managed: Expert fund managers professionally manage a fund of funds. They aim to maximize the returns of the fund with minimum risk.
Low investment: You can start investing in a fund of funds with an amount as low as Rs 1,000 through a systematic investment plan (SIP).
Expense ratio: The expense ratio of fund of funds can be higher than regular mutual funds, hence increasing the expenses of investment.
Risk of overlap of securities: Fund of funds invest in multiple mutual funds which may or may not have similar securities. Hence there is always a risk of overlap and over-diversification.
Taxation of fund of funds
For the purpose of taxation, fund of funds are treated as debt funds. The short-term capital gains, i.e., the gains before the period of three years, are taxed as per the investor’s income tax slab rate. In contrast, the long-term capital gains are taxed at 20% with indexation benefits.
What is a fund of funds, explain with example?
A fund of funds invests in other mutual funds. By investing in one fund of fund, an investor can get exposure to the assets of multiple mutual funds. There are many funds of funds in the Indian market. Some of them are ICICI Prudential Thematic fund of fund and Aditya Birla Sun Life Financial Planning Fund of Fund.
Are fund of funds good?
Fund of funds can be good investments provided you have long-term goals and are looking to diversify your investments across multiple securities and asset classes. Moreover, these funds are professionally managed and also have the potential to offer high returns at low risk.
Is FOF a debt or equity?
For the purpose of taxation, fund of funds is treated as debt funds. Both equity and debt fund of funds are taxed like debt funds.
Are fund of funds actively managed?
Fund of funds are actively managed funds. A fund manager does thorough market research and selects the funds for the portfolio. They also monitor the portfolio closely and rebalance it if necessary.
