Funds of Funds are a type of mutual fund investing in other mutual fund schemes. It is also known as a multi-manager investment. Instead of directly investing in stocks or bonds or other securities, a fund manager makes a portfolio of mutual funds. The underlying fund for FOFs is either from the same fund house or other fund houses.
Funds of funds aim to achieve sound diversification and appropriate asset allocation by investing in a variety of funds across different categories. This category of funds attracts small investors with low-risk appetite and also with access to a range of different asset classes. Thus these funds aim to ensure lower volatility of funds and aggressive returns for its investors.
FOFs are actively managed, and they undergo frequent reallocation of underlying funds to stay up to date with market fluctuations. They offer tax-friendly rebalancing of the portfolio. The FOFs offered in India belong to the same fund house. In the instances where investment is made in unaffiliated mutual funds (FOF investing in a different fund house), it attracts a higher cost versus the investment made from a related specialist. It is primarily because of the additional cost for investment management research.
With a wide range of Funds of Funds available in the market, the following FOFs are the ones that are in demand:
Though FOFs invest in equity mutual funds, their taxation is similar to that of a debt fund. Only upon redeeming their investment from the FOF the investor is taxed. The investor is not obligated to pay tax when the fund is actively managed by the fund manager, where he is frequently buying and selling the units of an underlying mutual fund.
FOFs also attract Dividend Distribution Tax when invested in equity securities of domestic companies. There is a dual levy of DDT for these FOFs. The dual DDT is when the companies distribute dividends to its shareholders and again when the FOF distributes it to its unit holders.
|Fund Type||Holding Period for Long Term||Short Term||Long Term|
|Equity Fund||1 year||15%||10% – If gains exceed Rs. 1 lakh in a year|
|Aggressive Hybrid Equity Fund||1 year||15%||10%|
|Other Hybrid Funds||If more than 65% of assets in equity, same as equity funds. Otherwise the same as debt funds.||If more than 65% of assets in equity, same as equity funds. Otherwise the same as debt funds.||If more than 65% of assets in equity, same as equity funds. Otherwise the same as debt funds.|
|Debt Fund||3 years||IT Slab rate||20% with indexation|
|International Funds||3 years||IT Slab rate||20% with indexation|
FOFs have a higher expense ratio. FOFs charge management fees on the service rendered for asset allocation. Compared to a regular fund, this fee is nominally high. The annual report of the fund clearly states all the applicable charges incurred during the operation of the fund. While investing, it’s quite essential to take into consideration the total expense, as it has a direct impact on the returns on investment.
FOFs allows its investors to invest in ETFs. An ETF is a portfolio that matches the composition of an Index in the same proportion. ETFs are traded on the stock exchange, unlike other mutual funds. Therefore, investors are required to have a Demat account to invest in ETFs. Ergo, to address this issue, fund houses have introduced FOFs with ETFs. This has opened the opportunity for all investors to invest in ETFs.
Majorly FOFs provide a good diversification for an investor with a single fund. However, it is always advised to weigh the pros and cons before investing. Firstly, evaluate the fund manager’s efficiency, pick a fund with the most experienced manager. Secondly, ensure that your investment objective is in line with that of the fund. Thirdly, based on your risk appetite, investment horizon, and tax implications, choose the fund that best matches your profile. And lastly, consider the high expense ratio of these funds.
Taxation on mutual funds is a complex topic. Taxes paid on your mutual fund investments vastly depend on factors such as what kind of funds you have invested in, the duration of your investment, which income tax slab you belong to and so on.