We all know a mutual fund invests in a particular type of asset, whether stocks, bonds, gilts or gold. But can you think about a mutual that invests in other mutual funds? Yes, that is true. These funds are called Fund of Funds (FoF).
Introduction to FoF
An FoF is a mutual fund that invests in other mutual funds belonging to the same fund house or belonging to other fund houses.
Basically, it is a collection of different mutual funds. These funds can be either debt or equity depending on the objective of the FoF. The FoF in India is Franklin India Dynamic PE Ratio Fund.
How does FoF work?
Normally when investing, the mutual fund will analyze the underlying securities it wishes to invest in. For example, an equity fund will analyze the stocks that meet its investment objective. Similarly a debt fund will analyze the various debt instruments as per its investment objective.
Similarly, an FoF will invest across various mutual funds depending on its investment objectives. It is a simpler method of investing in mutual funds as the most important decision of choosing the right funds to invest in, is taken by the fund manager of the FoF.
It saves you the trouble of trying to analyze the various funds available in the market and reduces your chances of selecting the wrong fund. Depending on your risk appetite, you can choose from very cautious funds that invest in cash and money market instruments to very aggressive funds investing completely in equities.
Expenses of FoF
One of the distinguishing factors that separate a normal mutual fund from FoF is the expenses. These funds carry an entry load of 2.25% and expenses to the extent of 0.75%.
Thus, the total expenses that these funds carry are around 3%. However the load here will be charged when you buy into FoF but not when the fund buys into its underlying funds.
Pros and cons of FoF:
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Pros |
Cons |
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Simplifies fund selection process |
FoF can change its choice of funds and you don't have any say in it |
|
More tax-efficient as you don't pay capital gains tax whenever the FoF transacts |
You pay dividend distribution tax as FoF is treated as debt fund even though it is equity fund. Also you will have to pay long-term capital gains tax. |
|
No need to monitor the underlying investments |
Higher expenses than normal mutual fund |
|
Allows you access to multiple funds with an amount as small as Rs 5000 |
You don't have a choice in the funds selected by the FoF. |
FoF is a convenient way to invest in multiple mutual funds with a very nominal amount. You don't have to spend time monitoring your investments, as the fund manager takes care of it.
However, it comes at a price as the expenses incurred by FoF are higher than a standard investment. If you are a tax-payer, you should also take care of the tax aspects of investing in these funds.
Moreover as with any mutual fund, you need to take consistent performance of the fund into account before investing. Once you are convinced that FoF are right for you, then go ahead and invest in them.
