In view of the capital markets regulator’s restrictions regarding actively-managed mutual funds (MFs) investing in foreign stocks, Fund of Funds (FoFs) have emerged as an alternative way to invest for investors since they invest in foreign exchange-traded funds (ETFs).
To capitalise on the investors’ sentiment, several fund houses have rolled out equity FoFs in the recent past. For instance, DSP Global Innovation Fund of Fund and Navi Mutual Fund's US Total Stock Market Fund of Fund were launched in February this year, and Aditya Birla Sun Life NASDAQ 100 Fund of Fund was launched in October last year, among others.
But these fund of funds are not for equity exposure only; they can be used for all types of mutual funds including debt and commodities
What is a fund of funds?
Let us first define what exactly is a fund of funds. It is a pool of funds brought together to invest in other funds, generally mutual and hedge funds, instead of directly investing in securities.
Investing in an FoF can turn out to be slightly more expensive when compared to regular funds. This is the result of an additional expense besides the funds in which this fund scheme is tied to.
For instance, the total expense ratio (TER) of one fund of fund is, say, 0.7 per cent, which would include 0.6 per cent of the underlying ETF fund then FOF will turn out to be 10 basis points more expensive.
But it is important to note that investing in ETF can be done only via a demat account and one cannot invest in them via systematic investment plans (SIPs).
Exposure to global stocks
Experts suggest that investing in a fund of funds is good for getting exposure to precious metals and global stocks.
“Fund of funds are good for investing in commodities such as silver and gold ETFs. Generally, one would require a demat account to be able to invest directly but as we know, one doesn’t need for investing in a mutual fund. Then there are Fund of funds which invest in global stocks, and the process is too complicated for retail investor. As far as equity FOFs are concerned, fund houses usually invest in their own funds which we don't recommend. There could be overlapping of more than 50 percent of funds, and it lacks diversification,” said S Sridharan, founder and principal officer, Wealth Ladder Direct.
There are 46 schemes of fund of funds (FOF) investing overseas, according to the latest AMFI (Association of Mutual Funds in India) data as on July 31.
There was a net inflow of ₹313 crore during July in these schemes and the net assets under management (AUM) as on July 31, 2022 were ₹21,175 crore under this category.
Tax treatment
As far as tax treatment is considered, a fund of funds is a non-equity fund and is therefore taxed. For investments held for fewer than 36 months (Short term capital gain), returns are added to the taxable income of the investors. Long-term capital gains (more than 36 months) are taxed 20% with benefits of indexation.
