Fund of Funds (FoF): Meaning, Types & How to Invest

Quick Facts

• Invests in a portfolio of mutual funds rather than individual securities.
• Helps spread risk across different funds and asset classes.
• Managed by professional fund managers.
• Available through both SIP and lump sum investments.
• Suitable for investors looking for diversification with a single investment.
• May have higher costs than regular mutual funds because of multiple layers of fund management.

Ideal Investor Profile

A Fund of Funds may be suitable if you:

• Want diversification without managing multiple mutual funds.
• Are a first-time investor looking for a simple investment option.
• Prefer professional portfolio management.
• Have a long-term investment horizon of at least five years.
• Want exposure to international markets, gold, or multiple asset classes through one fund.
   

Types of Fund of Funds

Different FoFs are designed for different investment goals. Here are the main types.

Multi-Manager Fund of Funds

These funds invest in mutual funds managed by different fund houses. This helps reduce dependence on a single fund manager while providing broader diversification.

Asset Allocation Fund of Funds

These FoFs invest across equity, debt, gold, and other asset classes. The allocation may change based on market conditions or follow a fixed investment strategy.

Gold Fund of Funds

Gold FoFs invest mainly in Gold ETFs. They allow investors to gain exposure to gold without opening a Demat account or buying physical gold.

ETF Fund of Funds

These funds invest in Exchange Traded Funds (ETFs). They provide exposure to different sectors, indices, commodities, or international markets through one investment.

International Fund of Funds

International FoFs invest in overseas mutual funds or global ETFs. They help investors diversify beyond the Indian market and participate in global growth opportunities.
 

Seven Must-Knows About Fund of Funds

Before investing, keep these important points in mind.

1. Diversification is the biggest advantage

A FoF invests across multiple funds, which helps reduce the impact of poor performance from any single fund.

2. Professional management

The fund manager selects, reviews, and rebalances the underlying funds. This saves investors the effort of managing multiple investments.

3. Higher expense ratio

Since you pay the expenses of both the FoF and the underlying funds, the total cost may be higher than investing in a single mutual fund.

4. Returns depend on the underlying funds

The performance of a FoF is linked to the performance of the funds it holds. Strong fund selection plays an important role in long-term returns.

5. Tax rules are different

Taxation depends on the type of FoF.

Most FoFs that invest less than 35% in domestic equities are treated as specified mutual funds under the current tax rules. Any gains are generally added to your total income and taxed according to your applicable income tax slab, regardless of how long you hold the investment.

FoFs that meet the required domestic equity exposure may be taxed differently under the applicable mutual fund tax rules. Since tax laws can change, it is important to check the latest regulations before investing.

6. Internal portfolio changes do not create tax liability for investors

When the fund manager changes the underlying funds within the portfolio, investors do not pay tax at that stage. Tax generally applies when investors redeem their FoF units, based on the applicable tax rules.

7. Long-term investing usually works better

Long-term investments generally tend to perform better. Since FoFs are also market-based investments, their suitability for long-term investments becomes apparent.
 

How to Choose a Fund of Funds?

The process of selecting an FoF gets simpler when one compares certain important aspects.

• Look at the past five-year performance of the fund instead of just relying on its recent performance.
• Consider the fund manager’s experience and investment philosophy.
• Compare the expense ratio with similar FoFs.
• Look at the underlying funds to avoid unnecessary overlap with your existing investments.
• Ensure the fund's investment objective matches your financial goals and risk appetite.
   

Numerical Example: FoF Taxation After the 2023 Rule Change

Suppose you invest ₹5,00,000 in a Fund of Funds that invests mainly in international mutual funds. After four years, the investment grows to ₹6,50,000.

• Investment amount: ₹5,00,000
• Redemption value: ₹6,50,000
• Capital gain: ₹1,50,000

Under the current tax rules applicable to most such FoFs, the gain of ₹1,50,000 is generally added to your taxable income and taxed according to your income tax slab.

Before the tax rule changes introduced in 2023, many such investments could qualify for long-term capital gains taxation with indexation after the required holding period. That benefit is no longer available for most FoFs that invest less than 35% in domestic equities. As a result, the tax payable may be higher for some investors.
 

Conclusion

It has become easier to make your portfolio diverse with the help of Fund of Funds due to the presence of professional management and diversified asset classes in it, making it ideal for both beginners as well as experienced investors. It is essential to consider various factors like expense ratio and tax while investing. It is necessary to compare the schemes to select the right one on the basis of the financial goals of the investor. The best way to invest in mutual funds like SIP or Fund of Funds is through 5paisa application.