Fund of Funds: A Comprehensive Guide to Diversified Investing in 2024
Instead of directly investing in stocks, bonds, or other securities, a Fund of Funds (FoF) is a kind of pooled investment that holds a portfolio of other investment funds. It can invest in several schemes from the same fund house or from different fund houses.
How Does It Work?
A FoF uses its pool of resources to invest in various mutual funds available in the market. The portfolio of a FoF can have varying degrees of risk, depending on the manager’s primary objective. For instance, if the goal is to maximize yields, the manager might target mutual funds with larger Net Asset Values (NAVs), even if they come with higher risks.
These funds may be used to invest in both domestic and international markets, depending on the asset management company’s discretion. This global reach allows for better diversification of the FoF’s investments. Highly skilled and experienced professional portfolio managers maintain FoFs. Their expertise helps ensure accurate market projections, reducing the likelihood of sustaining a loss.
Advantages of Investing in a Fund of Funds
1. Easy Rebalancing
Rebalancing is essential for managing an investment portfolio. Investors may need to sell some investments and buy others to maintain their desired portfolio balance. A FoF simplifies this process by rebalancing within the fund.
2. Diversification
The primary benefit of a FoF is that it allows investors to access a variety of mutual funds with different investment objectives through a single investment. By targeting the best-performing mutual funds in the market, a FoF optimizes both returns and risks, usually ensuring gains through diversification.
3. Multiple Investment Strategies
A FoF benefits from the expertise of various fund managers and their research teams, both domestically and internationally. Professional managers with extensive training and experience conduct thorough studies and make calculated market predictions, often leading to high returns.
4. Convenient Access to Global Markets and Gold
International FoFs make it easier to invest in global companies without needing to open a separate account with another intermediary. Investments in the stocks of multinational corporations can be started right away. Similarly, gold funds offer a straightforward way to invest in gold without the hassle of dealing with physical gold.
Disadvantages of Fund of Funds
1. Lack of Flexibility
The inability of investors to choose the particular mutual funds or investment methods that the fund manager uses is a major disadvantage of a fund of funds (FoF). If an investor is not happy with any fund, their only options are to sell their investment or keep investing in it.
2. Higher Expense Ratio
FoFs sometimes have a higher expense ratio, which is the annual fee charged by fund companies to manage investments. This ratio is calculated as a percentage of the fund’s overall assets. Although the expense ratio for funds-in-funds (FoFs) has been capped by SEBI and classified according to the underlying schemes, it may still be higher than that of individual mutual funds.
3. Potential for Portfolio Duplication
Since FoFs invest in various mutual funds, there is a possibility of exposure to the same stock or debt security across multiple funds. This duplication can limit the opportunity for diversification.
Conclusion
For beginner investors, a Fund of Funds can be a suitable starting point, as it provides a diversified collection of mutual funds investing in a variety of assets and securities. FoFs offer access to specific asset classes, including international companies and gold, which might be challenging to invest in through traditional mutual fund schemes. This makes them an attractive option for those looking to diversify their investment portfolio with ease.
