Fund of funds schemes are designed to achieve greater diversification than traditional mutual funds
A fund of funds is an investment fund that holds a portfolio of other investment funds rather than investing directly in shares, bonds, gold or other securities. This type of investment is also known as multi-manager investment. Just as a mutual fund invests in a number of different securities, a fund of funds scheme invests in many different mutual funds. The right fund to invest in is chosen by the fund manager.
Some of the fund of funds schemes are Quantum Equity Fund of Fund, Kotak Gold Fund, ING Global Real Estate Fund, HSBC Emerging Markets Fund, IDFC Asset Allocation Fund of Funds and DSP BlackRock World Gold Fund, HSBC Brazil Equity fund among others.
Pankaaj Maalde, Head-Financial Planning, ApnaPaisa.com, elaborated, “The investment objective of the fund of funds schemes is to provide long-term capital appreciation. A few of these schemes primarily invest in other mutual fund schemes, while some schemes predominantly invest in overseas mutual fund schemes and a certain portion of its corpus in money market securities. And some fund of funds schemes invest in gold ETFs (exchange traded funds) and other debt instruments with the purpose to enable investors to take exposure in gold and gold-mining companies.”
Types of schemes
At present, there are broadly three types of fund of funds on offer
- Funds that invest in the various schemes of the same fund house
- Funds investing in schemes offered by other fund houses
- Passively managed fund of funds schemes
Vidhata Bhide, research analyst, PersonalFN said, “Funds that invest in the various schemes of the other fund houses too are more promising provided the underlying mutual fund schemes are selected based on the process oriented analysis and not on the availability of the products/funds.” PersonalFN is a Mumbai based financial planning and mutual fund research firm.
Passively managed fund of funds schemes give passive exposure to fund(s) which are otherwise not accessible to mutual fund investors. Mr Bhide further added, “For example, a fund house offering gold fund of fund scheme investing in its own ETF. To buy units of an ETF, one must have a demat account. Therefore, those who do not own a demat account can still opt of the ETF by way of fund of fund route. Other example could be an offshore fund initiated in a foreign country and made accessible to domestic investors through fund of fund route.”
Diversification is the most basic function of fund of funds schemes. They are designed to achieve greater diversification than traditional mutual funds. A single investment could get the investor a diversified portfolio comprising of equity, debt, money market, bonds or gold.
These funds are also aimed at reducing the efforts of investors in selecting the right mutual fund schemes for their portfolio. Moreover, the onus of giving appropriate weightage to every underlying fund lies on the fund house offering the fund of funds scheme.
Expense fees on fund of funds are typically higher than those on regular funds because they include part of the expense fees charged by the underlying funds.
Thus, fund of funds scheme incurs double expenses. The first is of the fund itself, and second of the underlying fund. Since a fund of funds buys many different funds which themselves invest in many different stocks, it is possible for the fund of funds to own the same stock through several different funds and it can be difficult to keep track of the overall holdings.
Mr Bhide pointed out, “Investing in some fund of funds schemes can be disadvantageous owing to their structure and modus operandi i.e. method of operation. For instance, a fund of funds schemes invests in schemes offered by the same fund house. Seldom, all schemes from the same fund house perform well exposing an investor to a risk of being overweight on a particular fund house.”
Availability & load
Fund of funds schemes are mostly open-ended funds and do not have restrictions on the amount of shares or units the fund will issue. They are available at the face value of Rs. 10 per unit. These schemes don't levy any entry load.
Is premature withdrawal allowed?
Yes. Exit load will be levied on prevailing NAV (net asset value).
The scheme offers purchases and redemptions of units on all business days on an ongoing basis at NAV based prices, commencing after five business days from the date of allotment of units under the scheme.
These funds are treated as debt mutual funds for the purpose of tax. Even if the scheme is investing in Equity based mutual funds. The investor will have to bear a dividend distribution tax similar to a debt mutual fund.
Short term capital gains are charged to tax as per the tax slab. Long term capital gains are taxed at the rate of 10% (without Indexation) and 20% (with indexation).
Minimum investment & SIP
Some fund of funds schemes have minimum investment amount of Rs. 500, while some schemes start with minimum investment amount of Rs. 5,000. To counter market volatility, investors can start an SIP (systematic investment plan). Some schemes offer an SIP option of Rs. 100, while a few have an SIP option of Rs. 1,000. The scheme has two options viz. dividend and growth option. Further, the dividend option has the facility of payout and reinvestment.
Investment in the scheme should be viewed by an investor as a medium- to long-term investment as mutual funds carry normal market risks. Investors should study the terms of the schemes carefully before investing in the scheme. They should generally select well-known funds that have reputations for being fiscally strong. At the same time, investors usually need to have a long-term horizon for investing in these funds to beat inflation and get better returns.
All mutual funds are not alike
Making the right choice: Mutual funds