Investing in Fund of Funds

Do you find it easy and convenient while investing in mutual funds or have you ever faced the dilemma of choosing the right fit for your mutual fund portfolio from the vast universe of mutual funds.

 

Building and maintaining a quality mutual fund portfolio is not an easy task for sure; as you may not find it convenient to track and timely act on your mutual fund investments. It may also not be cost efficient if you frequently churn the holdings in your mutual fund portfolio. Many investors are in a tight spot for various reasons while investing in mutual funds.

 

Dilemma of investing in mutual funds

 

• Large number of schemes: As the investment universe has grown bigger, mutual fund industry has every now and then launched new products, which has left you as an investor with vast range of mutual fund schemes to choose from in the form of equity funds, hybrid funds, debt funds, liquid funds etc.
• Vast range of schemes increases confusion: It is quite natural that it may not be easy for you to choose the right fund from the vast universe, when it comes to investing your hard earned money.
• You incur cost on research and advice: To ease your mystification, you either utilize your valuable time to do your own research (by visiting various websites and checking the star ratings - which are arrived by past performance which may not be the same in future) as well as money to either buy research or take expert advise.
• Investing in a single mutual fund scheme may be risky: You know that investing your hard earned money in a single scheme may be risky incase of change in market sentiments, wrong calls or inefficiency of the fund manager. Hence you diversify your investment across various schemes.
• Diversification across multiple schemes also leads to multiple transactions: If you opt for diversification you may be left with few short listed but yet multiple schemes to invest in, which may lead to multiple transactions, filling up multiple forms, maintaining multiple account statement and tracking each fund separately.

 

Your comfort lies in investing in a single product portfolio which provides you diversification, while removing the hassle of maintaining and tracking multiple investments.

 

A "fund of funds" (FOF) is an investment strategy of holding a single portfolio of mutual funds rather than investing directly in various mutual funds. The main underlying investment of these funds is mutual funds (equity or debt as mandated) of the same or the other mutual fund houses.

 

FOFs invest their money in other funds / schemes of the same mutual fund house or other mutual fund houses. They hold a portfolio of other mutual funds and are not allowed to invest in any other FOF and or any instrument other than in mutual fund schemes/funds, except to such an extent where the fund requires liquidity to meet its redemption requirements, as disclosed in the offer document of the FOF scheme.

 

Pros of investing in FOFs

 

• FOFs are designed to provide greater diversification than regular mutual fund schemes
• Diversification helps reduction in volatility while maintaining average returns
• FOFs fund manager takes care of the research and process required to select the right fund in the portfolio
• The skills of the fund manager and the right selection process helps provide greater stability and take on some of the risk relating to the decisions of a single fund manager
• With multiple fund managers and schemes in the underlying portfolio, FOFs helps reduce the impact of bad performance by any of the fund manager or the fund
• FOFs provide small investors an opportunity to build a portfolio of well researched and quality funds by spreading their investments across mutual funds

 

Cons of investing in FOFs

 

• Your investment objective and asset allocation may not match as that followed by the FOF fund manager while choosing the underlying funds in the portfolio
• Net expense fees on FOFs are higher than those on regular funds because the fees is paid on both the FOF level and on the underlying investment fund, which is adjusted in net returns
• In terms of taxation, a FOF enjoys the status of debt mutual funds even if it invests 100% of its corpus in equity mutual funds

 

What to watch out for while investing in Fund of funds

 

• Check the investment objective and asset allocation as mandated for investment by the FOF (whether investing in equity or debt mutual fund schemes of in-house or other mutual fund houses)
• The investment process followed by the fund manager while choosing the underlying funds
• The track record of the underlying funds in its portfolio
• The latest portfolio holdings and underlying investment in terms of top stocks and sectors if available
• Past performance of the FOF if available

 

Tax implication on investing in FOFs

 

• As FOFs are classified as debt funds from tax perspective, even FOFs investing 100% of its corpus in equity mutual funds are taxed similar to debt funds
   

  	Short Term Capital Gains Tax (Period < 1 Year)	Long Term Capital Gains Tax (Period > 1 Year)	Dividend Distribution Tax	TDS
  	2010-11	2010-11	2010-11	2010-11
  Resident Individual / HUF	As per Tax Slab	10% (20% with Indexation)	13.841% (12.50% + 7.5% surcharge + 3% education cess)	Nil
  Partnership Firms / AOP / BOI	30%	10% (20% with Indexation)	22.145% (20% + 7.5% surcharge + 3% education cess)	Nil
  Domestic Companies	30%	10% (20% with Indexation)	22.145% (20% + 7.5% surcharge + 3% education cess)	Nil
  NRIs	As per Tax Slab	10% (20% with Indexation)	13.841% (12.50% + 7.5% surcharge + 3% education cess)	STCG - 30% ^ LTCG - 20% ^ (After Providing for Indexation)

  ^ Plus applicable surcharge and secondary and higher education cess.

 

Who should invest in FOFs

 

• Small investors willing to build a portfolio of quality mutual funds
• Investors who are new to mutual funds and lack resource of researching and choosing the right funds
• Investors who want to eliminate the cost incurred on research and advise on investment in regular mutual funds
• Investors who want to eliminate the hassle of maintaining and tracking their investment in multiple schemes

 

Why invest in Fund of funds

 

• FOFs are efficient products as they provide investors with the benefit of diversification in multiple and well researched mutual fund schemes
• FOFs eliminates the cost and hassle of investing, maintaining and tracking multiple mutual fund schemes
• New and small investors can hold a portfolio of quality mutual funds by investing in a single fund
• FOFs will be more efficient and investors will enjoy higher post tax returns once FOFs (focused towards investing in only equity mutual funds) gets the status of equity funds from taxation perspective

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Comments
research@personalfn.com Feb 07, 2011 Hi, There are many FoFs available in the market, but some act as feeder fund by investing in a selected fund (like DSP BlackRock), some invest in diversified funds of the same fund house (like Franklin Templeton, Birla SunLife etc.); while some invest in funds of third party / other fund houses (like Kotak, ING Optimix, and Quantum MF). While Feeder funds and fund of funds focusing on investment in own schemes are promoted to raise funds for their own / related funds. FoFs focusing on investing towards other fund house scheme are genuine and follow stringent process in selecting and offering a portfolio of best mutual fund schemes for the investors. Regards, PersonalFN Reasearch
amvaishnav@indiatimes.com Feb 07, 2011 Excepting one or two MFs, most of my past investments in most of Balanced Funds or Diversified funds during the same period.
vinodkvenugopal@gmail.com Jan 26, 2011 Can some one give me an example of FOF? Which are the FOF products currently available in market?

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