Mutual Fund vs FOFs: which is better for you:Mutual funds are becoming quite popular among common investors. The benefits of better returns and liquidity at low risk are the major reasons for the popularity of mutual funds. There is a special category of mutual funds, which is called Fund of Funds (FOF). This is an investment option in which the investors’ money is invested by dividing it into different mutual funds instead of investing directly in shares or bonds. That is, in this too, the investors’ money is ultimately invested in mutual funds. Then what is the need for such a fund of funds? How are these different from normal mutual funds and how right is it to invest in them?
What is the specialty of Fund of Funds?
As we mentioned earlier, Fund of Funds is a mutual fund scheme that invests investors’ money in different mutual funds instead of investing it directly in shares, bonds or other financial instruments. It is sometimes also called multi-manager investment, because in this the investor’s money is not only managed by the manager of the fund of funds, but the managers of the mutual funds in which the FOF invests also play an indirect role in the management of the fund. The biggest feature of the fund of funds is that the investment made through them becomes highly diversified. It is considered less risky than investing in a single fund.
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Difference between FOF and normal mutual funds
1. Investment Structure :Normal mutual funds invest directly in shares, bonds or other financial instruments available in the market. Whereas the managers of fund of funds invest the investors’ money in other mutual funds instead of investing it directly in the market.
2. Risk and Diversification:Investments made in normal mutual funds are comparatively less diversified. Sometimes the investment of the fund may be focused on a particular sector or theme, which increases the risk. Investing in many different mutual funds through fund of funds increases diversification and reduces risk.
3. Fund Management :The management of normal mutual funds is done by one or two fund managers, whereas the management of investments made through FOF involves the managers of all the funds in which the fund of funds manager invests your money. Because of this, FOF benefits from the experience and expertise of many fund managers.
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Benefits of Fund of Funds
Fund of Funds gives investors the opportunity to invest in multiple asset classes even with less capital. This helps in reducing the risk. All investments in FOFs are linked to a single folio number, which makes investment and redemption easier. Apart from this, there is no capital gains tax on rebalancing of investments within FOF, as it is considered an internal transaction. Investing in FOFs is beneficial for those investors who have less knowledge of the market.
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Drawbacks of Fund of Funds
High Expense Ratio:The expense ratio of a fund of funds can be higher than that of other mutual funds. This is because apart from the management fees of the FOF, it also includes the management expenses of all the mutual funds in which the FOF money is invested.
Tax Treatment :Another disadvantage of FOFs is that if its total investment in domestic listed companies (through other equity funds) is less than 90%, then it will not be considered an equity fund. If this happens, then that FOF will have to be taxed like a non-equity fund i.e. a debt fund.
Duplication of Portfolio :Sometimes, FOF may be invested in two or more mutual funds that have similar assets in their portfolios. This leads to duplication instead of true diversification.
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Should you invest in fund of funds?
To know the answer to this question, we should remember one thing: your money invested in fund of funds is also ultimately invested in normal mutual funds. Only some more layers of fund managers are added in between. So if you are a new investor and find it difficult to choose the right mutual funds for yourself in terms of diversification, then fund of funds can be a good option. Still, before investing, you must know about the expense ratio and tax treatment of FOF. But if you are ready to take risk for high returns and want to keep the investment expenses i.e. expense ratio low, then investing directly in normal mutual funds is a better option.
