Fund of Funds – Everything you need to know
A 'Fund of Funds' (FOF) is an investment strategy that involves keeping a portfolio of other investment funds instead of directly investing in stocks, bonds or other securities. A FOF scheme invests mainly in the units of another scheme of the Mutual Fund. This sort of investment is often referred to as investment by multi-managers
These schemes provide a chance for investors to diversify risk by distributing investments across various funds. Units of other mutual fund schemes are the underlying investments for a FOF either from the same mutual fund or from other mutual fund companies.
Experts think that the fund is usually better suited for smaller investors who wish to obtain access to a variety of distinct asset classes or those whose advisors do not have the knowledge to make suggestions for single managers.
Tax treatment on Fund of Funds
Under India's present income tax system, a FOF is regarded as a non-equity fund and taxed accordingly. In other words, while a FOF may be investing in equity-oriented funds (EOFs), the FOF itself is not considered to be an equity-oriented fund, and therefore the tax benefits currently available to an equity fund are not available to a FOF. Consequently, in the event of FOFs investing in national corporate equity securities through EOFs, there is a double tax on Dividend Distribution Tax (DDT), i.e. when national corporations distribute dividends to their shareholders and again when the FOF distributes dividends to their unitholders.
Why invest in Fund of Funds
Fund of Funds is based on the concept of using single but diverse investment plans to derive the highest advantage. Some of the advantages of investing in the Fund of Funds that should be considered are listed below:
- There will be no tax on capital gains for this internal transaction if you want to rebalance your assets. Therefore, there will be no tax on capital gains when your Fund of Funds is rebalanced to maintain such allocation between debt and equity.
- There are only one tracking NAV and only one tracking folio. This makes the decreased amount of resources that need to be managed, easy to handle.
- Investing in Fund of Funds enables you to attempt to invest in professionally managed funds before they can embark on the individual investment.
- Since Fund of Funds needs that its managers' backgrounds be checked and verified, you can be ensured that a reliable individual will handle your funds.
- Fund of Funds enables investors with limited capital to participate in diverse investments. Otherwise, such investors would find it difficult to access these assets separately.
Things to be considered as an investor
Before making any investment choice, you must weigh the pros and cons of Fund of Funds as an educated investor. Some of the disadvantages of investing in the Fund of Funds that one should be aware of are listed below:
- Fund of Funds, like any other arrangements of mutual funds, incurs expenses. But unlike mutual funds, it involves additional costs. In addition to the usual management and administrative expenses, there is an additional cost for the underlying resources. Despite the FOF expense ratio being only 1 percent, as an investor, you will still pay this sum on each fund owned by the FOF.
- The short-term capital gain tax would be applicable if sold before 36 months according to the investor's income tax slab. If the units are sold after 36 months, a 20 percent indexed long-term capital gain tax will be levied.
- Fund of Funds invests in several funds that invest further in many securities. This allows the Fund of Funds to end up owning the same stocks and securities through various funds. This decreases the diversification potential.
Fund of Funds for an investor with restricted knowledge and restricted funds can be an excellent investment option. Fund of funds such as mutual funds are subject to market risk and thus require the investor to become familiar with market hazards and investment policies.