What’s an FoF?

During an economic slowdown or recession, it is not advisable to follow a fixed investment style in mutual funds as it can be detrimental to the fund’s performance.

twitter-logoSameer Bhardwaj | Print Edition: December 25, 2008

During an economic slowdown or recession, it is not advisable to follow a fixed investment style in mutual funds as it can be detrimental to the fund’s performance. In such a scenario, one should diversify across investment styles or multiple investment portfolios. Fund of Funds or FoF is a category of mutual funds that provides such benefits. It is a scheme that invests in schemes of other mutual funds and aims at ideal diversification by spreading risks across a larger universe. Franklin Templeton was the first AMC to launch an FoF in India in 2003.

Types: There are two kinds of FoFs: asset allocation and single asset class. The former invests in both equity and debt schemes, while the latter invests only in one, equity or debt. The investment pattern and style vary from one AMC to another—some invest in schemes of the same AMC, while others do so in schemes floated by different fund houses.

Fund type3 mths (%)6 mths (%)1 yr (%)
Figures are category average returns as on 31 October 2008

Multiple diversification: An FoF takes diversification to a new level. As it invests in more than one scheme, it expands the investment portfolio to the maximum. For instance, an FoF can invest in top five best performing funds and offer the most extensively diversified range. The risk levels for wide portfolios are significantly lesser than those for individual fund portfolios.

Convenience: An FoF scores heavily on convenience as investors can do away with the continuous monitoring of the schemes’ performance as well as portfolio churning. So they don’t need to move from equity schemes to debt or vice versa depending on the future market outlook. The fund manager takes care of these.

Affordability: An FoF often invests in sought-after institutional funds that are beyond the reach of retail investors. For instance, if you want to invest in five equity funds and five debt funds, and the minimum investment required for each fund is Rs 5,000, you would need Rs 50,000. In an FoF, you can invest in 10 such funds for just Rs 5,000.

Expenses: One disadvantage of an FoF is the higher expenses or costs compared with the other equity mutual funds. This is because the investors have to bear the recurring costs as well as the expenses underlying the scheme. As there is a double layering of costs, its expense ratio is higher in comparison with the other funds.

Tax treatment: Another downside is the tax it invites. Though it is an equity-oriented fund, an FoF is considered a debt fund and liable to DDT of 12.5% (exclusive of surcharge, cess). Besides, an FoF is liable for LTCG tax of 10% without indexation benefits or 20% with indexation benefits (excluding surcharge, cess). DDT and LTCG tax are exempt for other equity mutual funds.

Previous instalment: Dealing with Change; Next issue: Reading a Fund Fact Sheet

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