An F0F provides you with the ease and benefits of investing in numerous funds in one transaction. A mutual fund that invests in other mutual funds is known as a fund of fund. Rather of investing directly in stocks or other things, the fund manager instead invests in a portfolio of mutual funds.
How Does a Fund of Funds Work?
Mutual funds invest in a variety of securities, including both stock and debt. On behalf of their investors, they invest in a company's stocks and debt documents.
An FoF is a mutual fund that invests in other mutual funds. Depending on the underlying investing strategy, the fund manager might invest in a single fund or funds from various fund houses.
Benefits of a Fund of Funds
Let's have a look at some of the most important benefits of FOFs.
Rebalancing is simple.
Rebalancing is crucial when it comes to maintaining your financial portfolio. When rebalancing your portfolio, you may need to sell certain investments and acquire others. If you sell investments in this situation, you may be subject to capital gains tax.
Portfolio rebalancing transactions carried out by the various funds that make up the FoFs, on the other hand, are exempt from capital gains tax. As a result, you can reap the rebalancing benefits while avoiding the tax burden.
Diversification
The primary benefit of a Fund of Funds is that it allows you to invest in a variety of mutual funds with diverse investment objectives all in one place.
Different Fund Managers' Investment Styles
FOFs invest in a variety of mutual funds, both local and foreign. As a result, FOF investors benefit from the opportunity to participate in a portfolio managed by a variety of fund managers and their research teams.
For instance, International FOF helps you benefit from experts in a specific market segment.
Investing In International Markets And Gold Is More Convenient
International FOFs can make investing in multinational corporations easier. To invest in stocks of global corporations, you do not need to open a separate account with another intermediary. You may get started investing right now with overseas funds. Gold ETFs, too, provide an accessible alternative to invest in paperless gold.
Fund of Funds Disadvantages
There are certain drawbacks to FOF, just as there are to everything excellent. Let's take a look at some of the disadvantages of FoFs.
Flexibility is lacking.
One significant downside of FOF is that investors are unable to select the mutual funds or investment strategy that a fund manager invests in. You have no choice but to stay involved or redeem your assets if you have already invested if you don't like one of the funds.
As a result, if a fund manager has invested in seven mutual funds, you will automatically have exposure to these funds.
Increased Expense Ratio
At times, FOFs may have a greater expenditure ratio. The Total Expense Ratio (TER) is a fee that fund companies charge to manage their investments on a yearly basis. It is expressed as a percentage of the fund's total assets. SEBI has also classified FoFs according to their underlying schemes and set a limit on the expense ratios they can charge.
FoFs that invest primarily in liquid, index, and ETF schemes, for example, can charge a maximum of 1%. FoFs that invest largely in actively managed equities and non-equity schemes, on the other hand, can charge up to 2.25 percent and 2%, respectively.
However, because they are liable for the expenses of the underlying schemes in which the FoF has invested, a few FOFs have a greater expense ratio than conventional schemes.
Consider the total expense ratios of two funds in the same category: ICICI Prudential Asset Allocator Fund (FOF) and ICICI Prudential Balanced Advantage Fund.
Portfolio Duplication Is A Possibility
Because FoFs invest in a variety of mutual funds, they may have several exposures to the same stock or debt product. Due to this condition, portfolio duplication may occur, limiting diversity.
It is not possible to get a tax break on your equity.
Mutual funds, including FoFs, are divided into two categories under income tax rules: equity-oriented funds and funds that aren't equity-oriented funds. Stocks and other equity-related instruments must typically account for at least 65 percent of an equity-oriented fund's assets.
The categorization criteria for FoFs, on the other hand, are slightly different. FoF is defined as an equity fund if it invests at least 90% of its money in Exchange Trading Funds (ETFs), which subsequently invest at least 90% of their assets in shares of Indian firms traded on stock markets. Even if a FOF invests 100% of its net assets in other equity funds, all other FOFs are taxed as debt or non-equity-oriented schemes.
If FoF is categorised as an equity fund, the tax on short-term capital gains (STCG) is 15% on assets sold within one year, and the tax on long-term capital gains (LTCG) is 10% on earnings exceeding Rs 1,00,000 sold after one year.
The short-term capital gains (STCG) tax is imposed if a FoF is categorised as a debt fund and units are redeemed within three years after acquisition. Gains are added to an individual's income and taxed according to the individual's tax bracket. For investments sold after three years, on the other hand, an LTCG tax of 20% with indexation applies.
Should you put money into a Fund Of Funds?
If you're a first-time investor, the fund of funds category, which is a collection of several mutual funds that invest in a variety of assets and securities, might be an excellent place to start.
Fund of Funds allows clients to participate in asset classes that would otherwise be impossible to access through traditional mutual fund schemes, such as overseas firms. As a result, if you are a seasoned investor, overseas funds can help you diversify your portfolio.
Make sure there isn't a lot of portfolio overlap with the other securities or assets in your portfolio before investing in a FoF. It's critical to make sure your investments meet your risk profile and are part of your overall asset allocation plan.
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