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What is a Fund of Funds?
Fund of funds is a Mutual Fund which utilises its pool of resources to invest in various other kinds of mutual funds available in the market. Alternatively, investment in hedge funds can also be made via this Mutual Fund.
Fund of funds MFs have portfolios of varying degree of risks, depending upon the main aim of the manager. If the primary target of the portfolio manager is to earn the highest yields possible, then mutual funds having higher NAV will be targeted, even though it is associated with a higher degree of risk. However, if the primary aim is stability, low-risk instruments will be acquired using the pool of financial resources obtained.
These mutual funds can be used to invest in both in domestic as well as international funds, as per the discretion of the asset management company. This increases the diversification of the fund of funds.
The essential characteristic of such Mutual Funds is that they are maintained by highly trained professional portfolio managers. This ensures accurate market predictions to a certain extent, minimizing the chances of incurring a loss.
Types of Fund of Funds
The following comprises the top fund of funds list in the country –
- Asset allocation funds
These funds consist of a diverse asset pool – with securities comprising of equity, debt instruments, precious metals, etc. This allows asset allocation funds to generate high returns through the best performing instrument, at a reduced risk level guaranteed by the relatively stable securities present in the portfolio.
- Gold funds
Investing in different Mutual Funds, primarily trading in gold securities are gold funds. Fund of funds belonging to this category can have a portfolio of Mutual Funds or the gold trading companies themselves, depending upon the concerned asset management company.
- International fund of funds
Mutual Funds operating in foreign countries are targeted by the international fund of funds. This allows investors to potentially yield higher returns through the best-performing stocks and bonds of the respective country.
- Multi-manager fund of funds
This is the most common type of fund of funds Mutual Funds available in the market. The asset base of such a fund comprises of various professionally managed Mutual Funds, all of which have a different portfolio concentration. A multi-manager fund of funds usually has multiple portfolio managers, each dealing with a specific asset present in the Mutual Fund.
- ETF Fund of Funds
Fund of funds comprising exchange-traded funds in their portfolio is a popular investment tool in the country. Investing in an ETF through fund of funds is more accessible than a direct investment in this instrument. This is because ETFs require a Demat trading account while investing in ETF fund of funds have no such limitations.
However, ETFs have a slightly higher risk factor associated with them as they are traded like shares in the stock market, making these fund of funds more susceptible to the volatility of the market.
Who should Invest in Fund of Funds?
The main aim of the top fund of funds is to maximise returns by investing in a varied portfolio posing minimal risk. Individuals with access to a small pool of financial resources which they can spare for a more extended period of time can choose such a Mutual Fund. Since the portfolio of such funds consists of varying types of Mutual Funds, it ensures access to high-value funds as well.
Ideally, investors with relatively fewer resources and low liquidity needs can choose to invest in the top fund of funds available in the market. This enables them to earn maximum returns at minimal risk.
Advantages of Investing in Fund of Funds
There are various benefits of investing in a fund of funds Mutual Fund –
Fund of funds target various best performing Mutual Funds in the market, each specialising in a particular asset or sector of fund. This ensures gains through diversification, as both returns and risks are optimised due to underlying portfolio variety.
- Professionally trained managers
Fund of funds is managed by highly trained people with years of experience. Proper analysis and calculated market predictions made by such portfolio managers ensure high yields through intricate investment strategies.
- Low resource requirements
An individual with limited financial resources can easily invest in the top fund of funds available to earn higher profits. Monthly investment schemes can also be availed while choosing a fund of funds to invest in.
Limitations of Fund of Funds
- Expense ratio
Expense ratios to manage a fund of funds Mutual Funds are higher than standard Mutual Funds, as it has a higher managing expense. Added expenses include primarily choosing the right asset to invest in, which keeps on fluctuating periodically. This expense amount to a substantial amount, and is deducted from the annual returns generated by the asset management company.
Tax levied on a fund of funds are payable by an investor, only during redemption of the principal amount. However, during recovery, both short-term and long-term capital gains are subjected to tax deductions, depending upon the annual income of the investor and the time period of investment. It should be noted that the dividend received on the investment is not taxable, as the burden is borne by the issuing fund house.
Things to Consider as an Investor
There are various factors which an investor should have complete information about before deciding to allocate his/her resources to these mutual funds –
- Top fund of funds operates in the long term, thus locking your investment for a considerable period. You should make sure your liquidity needs are satisfied through other sources before choosing to invest in this type of mutual fund.
- Even though the risk factor is minimised courtesy above par management and diversified investments characteristic to the top fund of funds, they are always subject to volatility due to market fluctuations.
Due to high expenses and tax implications of fund of funds mutual funds, the returns on investment in this scheme might be lower than the expectations of an investor.