Advantages of a FoF scheme

Funds of Funds

The Fund of Funds (FoF) scheme is a mutual fund that, based on the investment mandate, invests the pooled resources in other schemes – either from the same fund house or from separate fund houses.

As a result, by investing in just one fund, you virtually obtain the benefits of numerous funds.

Based on its investment mandate, a FoF plan may invest in domestic funds, i.e. in their home country, and/or offshore funds, also known as international fund of funds. Instead of equities, bonds, and money market instruments, a FoF's portfolio could include a variety of mutual fund schemes with varied compositions.

You can receive exposure to different mutual fund schemes managed by various fund managers by investing in this one fund. Regulatory requirements require a FoF scheme to invest at least 95 percent of its total assets in the underlying fund/s.

Equity Funds of Funds, Multi-manager Funds of Funds, Asset Allocation Funds of Funds (also known as Multi-Asset Funds of Funds), Global Funds of Funds, Life Stage or Managed Solutions Funds of Funds (for people in various age brackets looking at financial planning), Debt Funds of Funds (investing in an underlying gold ETF), Gold Funds (investing in an underlying gold ETF), and Gold Funds (investing in an underlying

The following are some of the benefits of a FoF scheme:

1. You can put a small amount of money into the market and reap the benefits of proper diversification.

2. The fund managers of the FoF's underlying mutual fund schemes use a variety of investment styles and methods, which you profit from.

3. Maintaining several accounts/folios and following multiple investments becomes less of a headache.

4. Avoids overloading your investment portfolio, making portfolio assessment and monitoring simple.

5. A FoF may be the sole way for ordinary investors to invest in particular international opportunities or themes.

6. Because you invest in one fund rather than numerous funds, the transaction cost is cheaper.

7. It reduces the tax burden while rebalancing the portfolio. You would have to pay the applicable tax if, for example, you were to remove a particular plan from your portfolio due to its poor performance and replace it with another scheme.

8. In a FoF, however, there is no tax responsibility for the investor when the fund manager shifts money from one fund to another.

However, there are some drawbacks as well.

Higher expense ratio: Depending on the type of FoF scheme, the expense ratio could be higher. This is due to the fact that expenses are effectively levied at two levels: 1) at the Fund of Funds level, and 2) at the level of the underlying investment schemes.

The rules for taxation differ from those for mutual funds: A FOF might be either equity or debt orientated for tax reasons. To be classed as equity oriented for tax purposes, a FOF must invest at least 90% of its assets in the units of another Exchange Traded Fund that invests at least 90% of its assets in the equity shares of publicly traded domestic companies. For tax purposes, all FOFs are classified as "non-equity orientated" or "debt schemes" and are taxed accordingly.

A Short Term Capital Gain (STCG) tax will be imposed if you redeem a FoF scheme that is classified as non-equity from a tax standpoint within 36 months of the investment date. The STCG is taxed at your marginal tax rate, plus any relevant surcharges and health and education cess for the current fiscal year. If you redeem it after 36 months or more from the date of investment, you will be subject to Long Term Capital Gains (LTCG) tax at a rate of 20% with indexation, i.e. after correcting for the Consumer Price Index (CII).

The holding term for taxes is 12 months if it is recognised as an equity-oriented FOF (from a tax standpoint). STCG Tax will be imposed if the units of such a scheme are redeemed within 12 months of the purchase date. If the units are redeemed after 12 months from the date of purchase, the gains over Rs 1 lakh will be subject to LTCG tax of 10% (without indexation advantage). The total LTCG in a financial year is limited to Rs 1 lakh.

The risk of one of the underlying schemes underperforming could have an impact on the FoF's overall performance: Given the FoF's structure, if the underlying mutual fund scheme in the FoF's portfolio fails to deliver returns, it runs the danger of driving down the FoF's total performance. As a result, it's critical to pay attention to portfolio features.