What are Funds of Funds

Fund of funds is a Mutual Fund which uses its pool of resources to invest in various other kinds of mutual funds available in the market. Investment in hedge funds can also be made via this kind of Mutual Fund. They are used to invest in both domestic as well as international funds. 
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Fund of funds MFs have portfolios of varying degree of risks. If the main aim of the portfolio manager is to earn the highest yields, then mutual funds having higher NAV will be targeted, despite a higher degree of risk. But if the primary aim is stability, low-risk instruments will be acquired. 

Types of Fund of Funds

  1. Gold funds-Investing in mutual Funds which mainly trade in gold securities are gold funds. They can have a portfolio of mutual Funds or the gold trading companies, depending upon the AMC.
  2. Asset allocation funds consist of a diverse asset pool –comprising equity, debt instruments, precious metals, etc allowing asset allocation funds to generate high returns through the best performing instrument, at a reduced risk level.
  3. ETF Fund of Funds with exchange-traded funds in their portfolio is a popular investment tool in the country. Investing in them is more accessible than a direct investment in this instrument as ETFs require a Demat trading account but an ETF fund of funds has no such limitations.ETFs carry a  higher risk factor as they are traded like shares in the stock market.
  4. International fund of funds operate in foreign countries and are targeted by the international fund of funds. They generate higher returns through the best-performing stocks and bonds of the respective country.
  5. Multi-manager fund of funds being the most common type of fund of funds, the asset base is made up of various professionally managed mutual Funds with a different portfolio, each manager dealing with a specific asset present in the fund.

Who should Invest?

Individuals with access to a small pool of financial resources which they can keep aside for a more extended period of time can opt for them. Investors with relatively fewer resources and low liquidity needs can choose to invest in the top fund of funds available. 

Advantages

1.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 them.

2.Fund of funds target various best performing mutual Funds in the market, each specialising in a particular asset or sector of fund. Gains are assured by diversification, as both returns and risks are optimised due to underlying portfolio variety.

3.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.

Drawbacks

  1. Expense ratios to manage a fund of funds mutual funds are higher due to higher managing expenses. This being a substantial amount, is deducted from the annual returns generated by the AMC. To invest in the right type of asset costs more and keeps on fluctuating.
  2. Tax levied on a fund of funds are payable by an investor at the time of redemption of the principal amount. 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.

There are various factors which an investor should consider before making investments in fund of funds:

Because of high expenses and tax implications of fund of funds mutual funds, the returns on investment in this scheme might be lower than expected.

Though the risk factor is minimised, they are subject to volatility due to market fluctuations.

They operate in the long term, locking investment for a long time. Liquidity needs should be taken care of by other sources before choosing this type of mutual fund.

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Krishna Rath is a SEBI Registered Investment Adviser, and since 2015 has been educating netizens on investments and insurance. Krishna is a fee only SEBI RIA and is Odisha's first SEBI RIA. With background in IT, Krishna is changing the advisory space with new innovations in AdvisoryTech.

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