Funds of Funds are professionally managed funds that invest in several types of funds. Retail investors with limited capital and who are unwilling to take too much risk can invest in such funds. As FoFs are highly diversified, the overall risk is reduced for investors.
Funds of Funds are a type of mutual fund that invests in other mutual funds to increase accessibility and diversification. FoFs (Funds of Funds) are managed by professionals who shortlist and select the funds for further investments.
Like a mutual fund, a FoF invests the collected money into various funds of a particular category to get the best returns. A FoF also invests in abroad markets to provide better reach to investors.
Funds of funds offer broad diversification due to their underlying nature. It picks other professionally managed portfolios so that even if a couple of assets doesn't perform well, the overall portfolio could deliver decent returns. Now the question arises who should invest in Fund of Funds!
Let's look at who would primarily invest in Fund of Funds.
1. Retail Investors with limited funds
Small retail invests can invest in Fund of Funds to get better exposure with limited capital. FOFs include many equity and debt securities which are beyond the reach of ordinary investors. With this instrument, small investors can access such investments and benefit from them.
In common equity shares, an individual has to purchase individual shares to construct a well-balanced portfolio. Whereas here, you can get multiple professionally managed portfolios all under one fund.
2. Risk-averse Investors
Fund of Fund provides excellent diversification which results in reduced risks or downside. Therefore investors who are not willing to take high risks can invest in such schemes. Additionally, you also invest in FoFs for the long term (3-5 years), therefore it also shrugs the short-term volatility of the market. The broad diversification of the funds also helps in reducing the overall volatility (Beta) of the portfolio.
These were the two primary types of investors who can look at investing in a Fund of Fund. Although these funds offer great benefits, it comes at a cost. The expense ratio of these funds is generally higher than traditional mutual funds. This is because of the multiple managers involved which in results increases the overall expenses. But even with the additional expenses, this remains a good proportion for small retail investors who are looking for global and domestic exposure.