What’s the Deal with Fund of Funds? Let’s Find Out

A video of an ice cream dosa recently went viral on the internet. If an ice cream shop can offer so many choices, then why can't mutual fund houses? There are manydifferent mutual fund types that you can choose from. While the most common ones includeequity funds, debt funds, and hybrid funds, there are several others too. One of these is a fund of funds. Rest assured, it is not as a typical as the ice cream dosa, but it does offer something new and unique. 

A fund of funds is a unique mutual fund that can add value to your portfolio for various reasons. Let's find out what these are, how you can invest in them, and what to expect when you do. 

What is a fund of funds?

Mutual funds pool in money from different investors and invest it in other equity and debt securities. A fund of funds follows the same technique but with a twist. These mutual funds pool in money from several investors and invest in other mutual funds. The portfolio of a fund of funds can include different types of funds. Moreover, these funds can invest internationally or domestically. 

What are the different types of funds of funds?

Here are the different types of funds of funds:

1. Gold fund of funds:Gold fund of funds invest in mutual funds investing in gold securities or directly in gold mining companies, companies trading in gold, etc. 
2. Asset allocation fund of funds:These funds invest in different asset classes such as equity, debt, or other commodities. These funds can offer capital appreciation along with stability due to a diversified asset class. 
3. International fund of funds: International fund of fundsinvest in mutual fund schemes of global companies, particularly equity. These funds can carry high risk as they are susceptible to currency fluctuations of the international market, but they can also offer consistent returns because of adequate global exposure. 
4. Exchange-traded fund of funds:Exchange-traded funds (ETFs) are investments traded directly on the stock exchange like shares. You need a Demat and trading account to buy and sell ETFs. However, if you do not have these and still want to add ETFs to your mutual fund portfolio, you can do so by opting for an exchange-traded fund of funds. These funds invest in ETFs for you, thus simplifying the process. 
5. Multi-manager fund of funds:These funds invest in other professionally managed mutual funds with different portfolios. This is an actively managed fund with multiple fund managers. 

Advantages of adding a fund of funds to your mutual fund portfolio

Here are some ways in which these funds can benefit you:

1. Diversification: With a single fund of funds, you can gain exposure to various mutual funds. This diversifies your portfolio, reduces risk, and may increase the scope of higher returns. 
2. Easy investment methods:Since these are mutual funds, you can invest through aSystematic Investment Plan (SIP), a systematic transfer plan (STP), or in lump sum. 
3. Professional management:Being an actively managed fund, you can benefit from the experience, investment strategy, and expertise of expert professionals. 
4. Hassle-free: Even though your money is indirectly invested in multiple mutual funds, you are primarily investing in only one fund of funds. This means you have one expense ratio, one Net Asset Value (NAV), and one exit load to keep in mind. 
5. Exposure to theinternational market: Investing in global stocks requires a separate account and broker. An international fund of funds minimises your troubles by allowing you to invest internationally without separately investing in international stocks. 

Limitations of adding a fund of funds to your mutual fund portfolio

Here are some limitations of adding these funds to your portfolio:

1. High expense ratio:A fund of funds can have a higher expense ratio than other mutual funds. This is because each mutual fund in the portfolio has a different expense ratio. Combined, this can add up to a lot.
2. Over-diversification:There is a thin line between diversification and over-diversification. While the former has many benefits, the latter can be damaging. If the mutual fund portfolio is over-diversified, you may not gain any real advantage from a particular asset class. 
3. Lack of flexibility:There is no option to choose mutual funds in a fund of funds. If you do not like a particular mutual fund in the portfolio, your money will still be invested in it. 

Conclusion

Afund of fundscan be a suitable option for long-term investors with a moderate risk appetite. With optimal diversification, this can be a good option to reduce risk. However, if you have a short investment horizon, investing in a fund of funds can add unnecessary volatility to your portfolio. Remember, your investments should lead to a better tomorrow, not to the doctor's office as in the case of the dosa flavoured ice cream. So choose carefully!

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