Fund of Funds or FoF is an investment vehicle where a Fund manager invests in other mutual funds or other funds. In simple terms, a fund of funds invests in various mutual funds to diversify further and obtain an average return of all the respective funds.
Unlike regular mutual funds, funds of funds don’t invest in direct equity. Instead, they invest in a portfolio of equity and debt through other funds. FoFs have the flexibility to invest in domestic as well as overseas markets for global diversification. Let’s look at an example to get a better understanding of the concept.
Let’s assume X wants to invest in the US stock market as well as the Indian and European stock markets. To invest in all these markets, X has to either invest in them individually or look for a fund that allows him to get exposure to all these markets. Fortunately, there is a Fund of Funds, ‘GE’, who owns index funds of all these respective indices. Therefore, X can simply invest in GE to get exposure to all the markets simultaneously.
1. Extreme Diversification
A Fund of Fund offers ultimate diversification to the investors. As there are multiple funds containing numerous assets, the risk is widely spread among the investments. Investors tend to beat the volatility and risky by investing in various funds all under one package.
Funds of Funds provide the accessibility to retail investors to numerous high-risk and high-priced assets at an affordable rate. These funds include some of the expensive assets that a retail investor would be unable to get individually. A FoF additionally provides access to global equities in an easy manner.
3. Multiple professionals handle these funds
Funds of Funds are managed by a dedicated portfolio manager who decides how much to invest where. These investments are further invested into funds that are managed by separate professionals which makes them multiple manager funds.
4. Higher Expense ratio results in lower returns
Not everything is perfect in FoFs. These funds are managed by multiple managers, thus the expense ratio is high. The investor has to bear the expense of multiple funds’ expense ratios which reduces the overall returns. Usually, an investor of a Fund of Fund pays two expense ratios. One for the original fund where the money is ultimately invested and the fees of the latter which invests the money there.
These were some of the key features of Funds of Funds. These funds are available in a vast variety which makes it easier for the investor to select from. Funds of Funds offer broad diversification and accessibility but are expensive in terms of expense ratios. These funds generally charge more when compared to any regular mutual fund or ETF (Exchange-Traded Fund).
However, investors with limited capital and who are willing to diversify can look at Funds of Funds for domestic as well as global exposure.