Investing in Funds of Funds: Pros and Cons, Benefits and drawbacks of investing in funds of funds.

Unlike other mutual funds that generally invest in stocks, bonds, or other securities, Fund of Funds invests in a portfolio of other mutual funds and hedge funds. Are you considering investing in a fund of funds? If the answer is yes - you should understand what it is and its pros and cons before going ahead.

Also Read: What Are Hedge Funds?

What is a fund of funds?

To understand the fund of funds, you should understand mutual funds. Mutual funds are schemes that invest your money in different financial instruments like equity, gold, bonds, etc. There are multiple mutual funds available across various categories. 

Also Read: Direct Mutual Fund or Regular Mutual Fund? Which One To Choose and Why?

A fund of funds (FoF) is also a mutual fund scheme that invests in other mutual fund schemes. Fund of funds does not invest in the underlying asset (stocks and bonds) directly but other mutual funds holding it. Typically, when you buy mutual funds, you buy from a particular fund house like HDFC, Kotak, Nippon, etc. FoF can invest in mutual fund schemes from multiple fund houses.

What are the different types of fund of funds?

Below are different types of FoF, so the first step is to decide which category is your requirement:

• Asset allocation funds - These invest in mutual funds from different asset classes like equity, gold, commodities, etc.
• Gold funds - These invest in mutual funds that invest in various forms of gold.
• International FoF - These consist of mutual funds comprising bonds and shares of global companies.

What are the benefits and drawbacks of FoF?

Advantages of FoF

• Tax advantage - Let us assume you invest in multiple mutual funds from the different asset classes. When you sell one of them to transfer the money to another (for rebalancing), you have to pay taxes on the capital gains. However, when a rebalancing happens in FoF, there is no tax on capital gains as it is an internal transaction.                             

Also Read: Different Types Of Funds Available Under Mutual Funds

• More for less - You hold multiple asset classes under one scheme - you don't have to track multiple schemes. You only track one Net Asset Value (NAV) and its performance.
• Professional Service - With a limited understanding of the market, you cannot invest in different asset classes with good knowledge. FoF comes with a professional service where a credible fund manager manages your portfolio.
• You can invest with limited capital - Let's say you can only invest Rs 2000 per month. You cannot invest this small amount in equity, gold, bonds, etc. - it won't be meaningful. FoF allows you to invest in all categories, even with a small amount.

 Also Read: Looking For Gold Load? Here's What Failing Gold Prices Could Mean For You?

Disadvantages of FoF

• Expense Ratio is on the higher side - Expense Ratio is the per cent a fund house deducts from the overall profit before sharing it with you. The expense ratio for FoF schemes is generally on the higher side.
• Over-diversification - Diversification is good, but over-diversification is not. In some cases, the FoF scheme ends up owning the same stocks and bonds through multiple schemes.

Should you invest in Fund of Funds?

FoF is a perfect option for investors who want to diversify their portfolio with a small investment. If you don't want to take more risks and have limited money to invest, you can start a SIP in an FoF. Also, you should have an investment horizon of at least five years if you plan to invest in this scheme.

We hope the above-discussed information will help you decide whether a fund of funds is the right investment option for you or not.