What is Fund of Funds? (FOFs)

The world of mutual funds comprises different schemes to suit different individuals. While equity, debt, and hybrid funds are commonly known, mutual funds, like a fund of funds, have also started to gain popularity. In this article, we will dive into the definition of fund of funds and more.

What is a fund of funds?

Mutual funds invest the pooled money of investors into different securities, such as shares and bonds, to earn profits. A fund of funds is a type of mutual fund that invests in the units of other mutual funds instead of individual securities. These units can be of the same fund house as well as others.

Let’s look at some types of a fund of funds.

Types of a fund of funds

1. Gold fund of funds: Such funds invest in mutual funds that hold gold or related assets. These can include mutual funds investing in gold securities or gold mining companies, etc.
2. Asset allocation fund of funds: Also known as multi-asset fund of funds, these funds aim to diversify by investing across various asset classes such as equity, debt, and commodities. This strategy helps in balancing risk and returns.
3. International fund of funds: International funds invest in mutual fund schemes that target global companies. Such funds allow you to look beyond the domestic market and explore international securities.
4. Multi-manager fund of funds: Such funds invest in multiple professionally managed mutual funds. Each mutual fund in the portfolio has a separate fund manager who brings their expertise and investment philosophies to the table, thereby enhancing risk management.
5. Exchange-traded fund of funds: Traded directly on stock exchanges, Exchange-traded Funds (ETFs) are a combination of stocks and mutual funds. ETF fund of funds are mutual funds that invest in ETFs.
6. Sector-specific fund of funds: Such funds choose mutual funds focusing on a particular sector or industry, such as technology or banking, in order to capitalise on its growth potential.

Let’s move on to the pros and cons of a fund of funds.

Advantages of a fund of funds

1. Diversification: Mutual funds are inherently diversified investments. A fund of funds offers a second layer of diversification by investing in different funds, thereby minimising risks.
2. Convenience: Apart from benefitting from the professional fund management of the underlying funds, you get to explore a wide range of securities through a single investment. Managing and tracking your investment becomes hassle-free.
3. Ease of investment: Different fund of funds offer different benefits. For example, an international fund of funds allows you to invest in international stocks without having to open a separate account through a broker. On the other hand, an ETF fund of funds eliminates the need to open a demat and trading account, which is otherwise required for ETF investments.

Disadvantages of a fund of funds

1. High expense ratio: Mutual funds charge a management fee, known as the expense ratio. A fund of funds comes with a higher expense ratio because it involves many funds, each with its own expense ratio.
2. Risks of over-diversification: While diversification offers several benefits, over-diversification can be detrimental to the interests of the portfolio. Investing in too many funds not only adds to costs and complexities but also leads to diluted returns.
3. Lack of flexibility: A fund manager plays an important role in the performance of a fund of funds. You have to rely heavily on their choices and have no control over the selection of funds.

How to invest in a fund of funds?

Since a fund of funds is simply a type of mutual fund, the investment process remains the same. You can either make a lump sum investment or consider a Systematic Investment Plan (SIP). To invest, you can directly visit the website of your chosen Asset Management Company (AMC) or use their mobile application. Thanks to technology, you can add a fund of funds to your portfolio with a few clicks.

To sum it up

A fund of funds is a type of mutual fund that invests in other mutual funds. Moreover, its unique investment mechanism is suited to new investors who do not have enough investment knowledge to manage a well-diversified portfolio.  

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