Definition of Fund of Funds
Fund of Funds (FoF) is a mutual fund that invests in a portfolio of other mutual funds or hedge funds rather than investing in stocks, bonds, or other securities as in the case of other mutual funds. Since, the fund invests further in various professionally managed funds, the fund of funds is referred to as a multi-manager investment fund.
Explanation
If you have heard of mutual funds you might be knowing that mutual funds invest in different asset classes such as bonds, stocks, and other securities of different companies. A fund of funds is such an investment fund that utilizes its fund in the creation of a portfolio that consists of units or stocks of various mutual funds or sometimes hedge funds. The strategy of the fund of funds is to diversify the funds in different asset classes by investing in different mutual funds or hedge funds and thereby maximize returns. Mutual funds are managed by professional fund managers and thus, a fund of funds enjoys the privilege of being managed by a large number of fund managers since it invests in a number of mutual funds.
How Does It Work?
A fund of funds invests in different mutual funds as per its investment objective or sometimes in hedge funds too. By investing in different mutual funds, the assets of the fund of funds get diversified into all those asset classes in which the underlying mutual fund invests. This helps the fund in portfolio and risk diversification. The overall risk involved in the fund of funds is reduced as compared to other funds since it invests in a number of mutual funds that are professionally managed by mutual funds. The returns generated by the fund through the investments are distributed to the holders of the units of the fund in proportion to the units held by them. The expense ratio is high in the case of fund of funds since these funds are multi-manager investment funds and thus the cost of professionally managing and maintaining the funds is high.
Types of Fund of Funds
Fund of funds can be categorized into two main types as follows:
- Overseas Fund of Funds: These are the fund of funds that invest in foreign mutual funds. The advantage of these funds is that investors are able to diversify the funds in foreign stocks as well.
- ETF Fund of Funds: This type of fund of funds invests in exchange-traded funds (ETFs). Units of ETFs, unlike other mutual funds, trade continuously trade on the stock exchange. Since many investors don’t have access to trading accounts, they are unable to invest in ETFs. By investing in FoFs, such investors are able to invest in ETFs through the fund.
Who Should Invest in Fund of Funds?
Fund of funds is apt for those investors who want to take a minimum risk and diversify their funds in different asset classes. The fund of funds invests in mutual funds which further invest in different asset classes such as stocks, bonds, and so on. Further, these mutual funds invest in securities of companies operating in different sectors. Thus, by investing in a fund of funds, an investor can diversify the funds in different securities of companies operating in different sectors. Such diversification reduces the overall market risk of the portfolio.
Thus, those investors who have a lower risk appetite should opt for the fund of funds.
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Top 5 Fund of Funds in India
If you are looking for the top-performing fund of funds in India, you can refer to the following list of top 5 fund of funds in India:
- PGIM India Global Agribusiness Offshore Fund
- Kotak Asset Allocator Fund
- IDFC All Seasons Bond Fund
- ICICI Prudential Advisor Series- Debt Management Fund
- Aditya Birla Sun Life Financial Planning FOF Aggressive Plan
Advantages of Fund of Funds
Some of the advantages are given below:
- Professional Management of Funds: Fund of funds invest in mutual funds that are managed by professional fund managers. Thus, investing in a fund of funds means relying on the professional experience of a number of fund managers.
- Diversification of Funds: These funds get the benefit of diversification of the funds in the mutual funds specializing in different asset classes as well as sectors. For those investors who don’t have sufficient funds to invest in each underlying mutual fund separately, it is a great choice to invest in units of fund of funds so that returns are maximized and risks are reduced.
- Less Investment Required: An investor with limited resources can invest in a fund of funds and enjoy the benefits of diversification of funds. Further, an investor can also take advantage of monthly investment schemes offered by the fund of funds.
Disadvantages of Fund of Funds
Some of the disadvantages are given below:
- High Expense Ratio: The expense ratio, which indicates the extent of annual operating expenses and management fees of a fund as against its asset value, is high in the case of fund of funds since the mutual funds it invests in pass their share of annual fund management cost as well.
- Less Returns: Since the funds are diversified in the case of a fund of funds, the returns are also reduced. Thus, if an investor has good knowledge of the stock market it is better that the investor makes investments in individual asset classes such as stocks, bonds, mutual funds, etc. and earn higher returns by assuming higher risks.
- Less Transparent: The fund of funds invests in different mutual funds and for investors, it might become difficult to keep track of the asset portfolio of each of such mutual funds.
Conclusion
Fund of funds is the investment fund that invest in mutual funds and hedge funds. They allow the investors to diversify their funds by way of investment in different mutual funds. The investors enjoy diversification of funds and overall reduced risk.
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