Fund of Funds: How does it work
Author : Quantum AMC | Published On : 30 Aug 2021
The meaning of a fund of funds (FOF) is a type of Mutual Fund scheme that invests in other mutual fund schemes. The fund of funds aims to achieve diversification and appropriate asset mix in a variety of fund categories. Fund of Funds comprises a mutual fund scheme with different underlying schemes of other funds. Fund of Funds has several benefits. Let us understand them in detail:
- Professional Fund Management:
Investing in a Fund of Funds gives the investor professional fund management. Out of the 44 registered mutual fund companies in India, it becomes cumbersome to pick a fund that would cater to the diverse needs of investors. In a Fund of Funds, the fund manager picks the mutual fund that is in tandem with the investment mandate.
- Less exposure to market volatility:
When you invest in Fund of Funds, a lot of research goes into managing the scheme and fund managers generally ensures that that there is no overlapping of underlying portfolios across multiple mutual funds.
- Low Minimum Investment:
Fund of Funds offers the opportunity to invest in some of the top-performing mutual funds even with a limited investment budget. Also, when the fund manager rebalances fund of funds between equity and debt, the investor won’t have to pay any capital gains tax.
- Indexation benefit:
Inflation is reducing the purchasing power of our money. Fund of Funds taxation comes with indexation benefits. Indexation is used to adjust the purchase price of an investment to reflect the effect of inflation on it. Long term capital gain from Fund of Funds are subject to indexation, and indexation lowers the long-term capital gains tax which brings down investor’s taxable income.
- Ease of investment:
Instead of directly investing in mutual funds, investing in Fund of Funds becomes a hassle-free and convenient option for investors. Thus, an investor would not be required to track multiple portfolios and would instead just have to manage a single mutual fund.
While Fund of Funds is one way to go about building your portfolio. Those preferring a hands-on approach can look at shortlisting mutual funds through a host of quantitative and qualitative parameters. Quantitative parameters could include looking at the fund performance across market cycles, the consistency of the fund performance, the potential to provide risk-adjusted returns over the long term, etc. Qualitative parameters could include the quality of fund management, the fund manager’s philosophy, investment processes followed, etc.
Thus, Fund of Funds seeks to diversify the risk across different asset classes and optimize returns. If you are a first-time investor and want the flexibility of diversifying your investments with a minimum investment budget with limited risk, then you could consider investing in a fund of funds.
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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.