What are Fund of Funds - meaning, types and benefits

Every new year brings with it myriad opportunities in people’s lives and one of these opportunities revolves around investing. If you are wondering about where to invest your money in the new year, or how to diversify your portfolio optimally, then there may be an option you have been overlooking and that is fund of funds. You may be wondering what are fund of funds so here’s a quick explainer, along with everything else you need to know, before deciding whether or not this is a suitable option for you.

What Are Fund of Funds (FOF)?

Usually a means to invest in international funds, fund of funds refers to a pooled investment fund which parks its corpus in other mutual fund types. For instance, a fund of funds in India may invest in different mutual funds such as a Nasdaq100 fund, or a global renewable energy fund, based on its underlying strategy. Therefore, fund of funds does not undertake any transactions or investment decisions on their own – they simply look for a suitable scheme and then place their bets on it. Fund of funds is an excellent way for you to invest in international mutual funds.  

How Do They Work?

Now that you know what are fund of funds, let’s see how these funds actually work. Most fund of funds have a fixed strategy in focus, and this usually revolves around achieving broad diversification via investments in different fund categories. So, a global benchmark fund of funds may allocate its corpus to different mutual fund schemes investing in global indexes like the S&P, the Nikkei and the Kospi, among others. Based on their objectives and strategies, there are different types of fund of funds and you can easily find one that suits your investment goals and return requirements. 

Advantages to Keep in Mind

Fund of funds are frequently preferred by retail investors who are keen on diversifying their portfolio without taking on too much risk. They can mitigate the underlying risk by investing via these schemes, instead of dipping their toes directly in the market. Further, fund of funds is also an excellent opportunity for geographical diversification, as these funds enable you to participate in the growth of international funds and markets. Another advantage of this option is that you can start with a small investment corpus – while you would otherwise require a large amount of money to enjoy optimal diversification, with fund of funds, even your limited capital will be diversified efficiently, helping you optimise returns and minimise risk.

Fund of funds can also help you invest in high return alternative investment options like hedge funds, which are usually not accessible for retail investors. Finally, when you invest in these schemes, you will be able to benefit from the expertise and knowledge of the professional fund managers who handle the underlying schemes in which your fund of funds invests. This means that you have the ability to partake in the robust returns unlocked by these managers, making it a great choice for your new year investment portfolio.  

Disadvantages to Consider 

One of the major disadvantages of fund of funds is that these schemes usually charge higher investment fees than traditional funds. This could eat into some of your returns. However, if you pick a solid fund which invests across growth segments and has the ability to offer you robust returns, then the fee would not bite as much. Another disadvantage to consider revolves around the fact that there is no active fund management being undertaken by your fund of funds – so, your portfolio will reflect the returns generated by the underlying funds and, in a volatile market, they may not be as good as you hoped for. Finally, if the fund of funds ends up investing in similar sectors or funds, your portfolio diversification may get limited. You can avoid this by choosing a fund that is most aligned with your investment profile and requirements.

Now that you have a detailed understanding of fund of funds, all you have to do is decide whether or not they would be a suitable addition to your portfolio. This new year could be the best time to add a new dimension to your portfolio but be sure to choose wisely and read the fine print. 

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