What Is a Fund of Funds (FOF)

October 19, 2021 Trading 3 min read
What is a Fund Of Funds

A Fund of Funds is somewhat like a mutual fund. The significant difference here is that this fund contains several investment funds, not stocks, bonds, etc. Lately, many investors are investing in Fund of Funds for diversification and reducing risk. Through an FOF, a retail investor can get deeper access to the investment market.

Let’s take an FOF, namely X. It would contain several funds, which in turn would hold stocks, mutual funds, bonds, etc. Therefore, this X FOF would still invest in these instruments, albeit indirectly. Now that we have understood the “fund of funds meaning”, let’s delve deeper.

Broadly, there are two kinds of Fund of Funds – Fettered and Unfettered. A Fettered FOF makes investments in funds floated by the parent company. On the other hand, an Unfettered Fund of Funds can invest in instruments across the board.

The first Fund of Funds was launched in the 1970s. However, it wasn’t until the 1990s that the size and numbers of Fund of Funds started increasing.

How does Fund of Funds work?

The main objective of an FOF is to diversify the portfolio while ensuring an effective allocation of the assets in various fund categories. Every fund category can be structured according to its investment objectives. Professional and Retail investors can use these fund categories to develop their portfolios.

You can participate in various Fund of Funds, such as Mutual Fund FOF, Hedge Fund, Private Equity Fund, and so on. These funds, as we have seen earlier, can be Fettered or Unfettered.

However, a Fund of Funds has a higher expense ratio than regular mutual funds. Some top Fund of Funds in India are SBI Nifty Index Fund, ICICI Prudential Nifty Index Fund, ICICI Prudential Advisor Series, Aditya Birla Sunlife Index Fund, etc.

It’s easy investing in an FOF. Contact your broker, open a Demat account, and make your first deposit.

Fund of Funds advantages

There are several reasons why one should invest in a Fund of Funds.

First, these funds are managed by the best professional fund managers in the business. Managing an FOF requires a very high level of competency, and only those managers who have demonstrated excellence over a period of time are considered for this role.

Secondly, you can diversify your assets in such a fund and optimize your profits. For example, you can choose a Fund of Funds whose investment portfolio contains stocks of the companies of the best performing sectors. This way, you focus on not just one or two good stocks but hundreds of performing stocks.

Third, the cost of entering an FOF is quite low. Investors with a lower budget can also participate in various Fund of Funds. You can also avail of monthly investment schemes to participate in FOFs.

Finally, there is moderate to low risk in any Fund of Funds. Since the money is invested in different schemes and funds, the Fund of Funds is protected against volatility and fluctuations.

Fund of Funds disadvantages

The biggest thing going against an FOF is its high expense ratio. Typically, the management fees of a Fund of Funds borders on the higher side. This is because the fee includes the management fees of the various underlying funds in the basket. This drives up the expense ratio and sometimes makes an FOF look unprofitable.

The other disadvantage of an FOF is regarding asset overlapping. Since you are essentially investing in funds, you have very little knowledge of the assets being covered. Sometimes, two different funds might be investing in the banking sector. This overlapping can reduce your profits.

Now that we have fully understood “fund of funds meaning, let’s look at some real-world examples.

Real-world example of Fund of Funds

A good example of a Fund of Funds is the UTI Nifty Index Fund. There are two objectives of this fund. The first is to invest in the stocks comprising the Nifty 50 Index. The second objective is to achieve returns that are nearly equal to the Nifty Index. The fund managers try to replicate the weightage of this fund with that of the Nifty 50 Index while minimizing the performance differences between this Fund and the Index.

The UTI Nifty Index Fund was launched way back in 2000. This fund has a moderate to high risk and has delivered a CAGR of 12% since its inception. Ranked 68th in its category, this fund’s return was 15 % in 2020, 13.2% in 2019, and 4,3% in 2018.

The Net Asset Value of the UTI Nifty Index Fund was INR 115.559 as of September 14, 2021. UTI Asset Management Company Limited manages this fund.

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