Fund of Funds- Fund of Funds Definition and Meaning

Now that you know Fund of Funds meaning and types, here are the top features:

• High Diversification

  Mutual funds offer a lot of diversification by investing in multiple instruments of the same or different asset classes. By investing in mutual funds, FOFs take diversification to an entirely different level.

• Lower Risk Exposure

  FOFs are generally known to be moderately risky. As the money is invested in multiple funds and schemes, FOFs are protected against high volatility and short-term fluctuations. If a particular fund or asset class is underperforming, other funds/schemes or asset classes add stability to the portfolio.

• Taxation of FOFs

  FOFs are considered as debt funds even if a FOF only invests in equity funds. For investments held over 36 months, LTCG (Long-Term Capital Gains) at the rate of 20% with indexation benefit is applicable. The returns from investments held for less than 36 months are added to the taxable income of the investor and are taxed accordingly.

• High Expense Ratio

  The funds and schemes that FOFs invest in have their own expense ratios. Combine it with the expense ratio of the FOF, and you are looking at an expense ratio that is higher than standard expense ratios of equity and debt schemes.

• Over-Diversification

  While diversification is good, over-diversification can harm your investment portfolio. This is mostly because over-diversified investments are not able to make the best use of a particular asset or instrument when they are outperforming. So, if you plan to invest in FOFs, manage your portfolio exposure accordingly.

• Asset Class Over-Lapping

  If a FOF you select, invests in multiple equity funds, there is a high chance of over-lapping of asset classes or instruments. For instance, two equity funds might have significant exposure to the banking sector. If the banking sector starts underperforming, this could significantly affect your investment.

Investors who want to invest in multiple mutual fund schemes can consider investing in a FOF. A single FOF investment could provide access to investments across various schemes. Also, as these funds are highly diversified, their risk level is generally moderate. So, even risk-averse investors can invest in these funds.

But note that FOFs, too, are generally ideal for long-term investments. So, prefer them if you have an investment horizon of above three years.

Before investing, try to know more about what Fund of Funds in detail is, their advantages, risks, types, and more to ensure that they meet your investment profile and financial objectives. Rather than focusing on generating quick profits, try to become a savvy investor as this will prove more beneficial in the longer run.