What is fund of funds (FOF) in mutual funds?

A fund of funds means a mutual fund scheme that diversifies investors' portfolios by pooling their money and investing it across a wide range of other mutual funds. So, instead of directly investing in stocks and bonds, an FOF puts money into same/different funds managed by various fund houses.

For example, an FOF may allocate 40% of its corpus to large-cap funds, 30% to multi-cap funds, 15% to international funds and so on, all through investing in different underlying schemes. This allows investors easy access to a pre-diversified portfolio without having to build it themselves.

Types of FOFs in India

There are mainly two types of Fund of Funds based on the nature of underlying schemes.

Domestic FOFs: These funds invest in diversified domestic funds like equity, debt, hybrid and other mutual fund categories available in India.

International FOFs: They allocate funds across various international markets by putting money in global equity funds offered by Indian fund houses. This provides exposure to both developed and emerging markets.

Benefits of FOFs

Diversification: FOFs give instant access to a pre-diversified portfolio spanning different assets, fund categories and markets.

Expert selection: Professional fund managers choose suitable underlying funds based on thorough analysis.

Convenience: Investors only have to select one FOF instead of multiple individual funds.

Simplified accounts: Investors receive one consolidated statement for the FOF.

Flexibility: Contributions and withdrawals can be easily made from the FOF.

These qualities make FOFs suitable for investors looking for a simple 'set and forget' investment option.

Things to consider

While FOFs provide risk mitigation benefits, some factors to be aware of include:

Additional expense: The charges of underlying funds are layered onto the FOF's expense ratio.

Lack of control: Investors have limited control over the underlying fund selection.

Complex structure: Performance depends on how the FOF and its chosen sub-funds perform.

If there are restrictions imposed on any of the underlying investments then the FoF that has invested will also bear the impact of such restrictons.

So, investors need to consider the extra costs and multi-layer structure while choosing an optimal FOF for their needs and risk profile.

Regulation of FOFs in India

In India, the Securities and Exchange Board of India (SEBI) lays down the regulatory framework for FOFs. Key directives include the below.

  • FOFs cannot invest in other FOF schemes to prevent an infinite investment structure.
  • Expense ratio of FOF and underlying funds cannot exceed 2.25% as per total expense limits. This however is the maximum applicable that too for FOFs investing minimum 65% in equity oriented schemes. The limits for investing in other than equity oriented schemes or liquid schemes, index fund and ETF is much lesser.
  • Detailed disclosures about investments, performance and costs are mandated periodically.

These SEBI regulations aim to address risks while facilitating orderly growth of the FOF segment in the Indian mutual fund industry.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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