What is FOF? Meaning, Types and How to Choose 

Key Takeaways 

• FOFs can provide diversification across asset classes, strategies, fund managers or markets through a single investment. 

• Different types of FOFs include domestic, international, multi-asset and fund-specific structures. 

• Investors should consider the FOF’s investment strategy, underlying funds, costs, risk level and past performance before investing. 

• FOFs may suit investors seeking diversification and professional fund selection, but they can involve layered costs and market-related risks. 

A mutual fund can invest directly in shares or bonds, but a FOF (Fund of Funds) invests in other mutual funds or ETFs instead. This structure can give investors exposure to multiple schemes through a single investment. But convenience can also mean an additional layer of costs and different tax treatment.  

This guide explains the meaning of a fund of funds, its types, costs, taxation, key benefits and what to consider when choosing one. 

What is FOF? 

A FOF or multi-manager investment is a mutual fund scheme whose portfolio is made up of units of other mutual funds or ETFs rather than direct securities. 

In simple terms, instead of selecting individual stocks, bonds or other securities, the fund of funds invests in other schemes that already hold those assets. The investor therefore gets a ready-made basket of funds through a single folio. 

The underlying schemes determine the kind of exposure the multi-manager investment provides. For example, an international FOF may invest in overseas equity funds, while a gold ETF FOF may invest in gold ETFs. This makes the structure useful for investors who want diversified exposure without managing several fund investments separately. 

Fund of Funds Definition and How It Works 

The fund of funds definition is easiest to understand through its two-layer structure. First, an investor buys units of the multi-manager investment. The FOF then invests that money in units of one or more underlying mutual funds or ETFs. Those underlying schemes, in turn, invest in securities according to their own objectives. 

The multi-manager investment’s NAV therefore reflects the changing value of its underlying holdings after accounting for applicable expenses and other factors. The investor does not directly own the shares, bonds or other securities held by the underlying schemes. Instead, they own units of the FOF. 

For a clearer explanation of NAV, read what NAV means and how it is calculated. 

Types of Fund of Funds 

The types of fund of funds available to investors differ based on the assets, markets or strategies followed by their underlying schemes. 

Asset Allocation or Multi-Asset Fund of Funds 

These multi-manager investments typically invest across equity, debt, gold or other mutual fund categories according to a defined asset allocation strategy. They may suit investors looking for diversified exposure through one scheme rather than managing multiple asset classes themselves. 

Overseas or International Fund of Funds 

These schemes generally invest in international mutual funds or ETFs that provide exposure to overseas markets, companies or indices. They can suit investors seeking geographical diversification beyond Indian markets, subject to currency, taxation and regulatory considerations. 

Gold and Silver ETF Fund of Funds 

These funds typically invest in gold or silver ETFs, giving investors exposure to precious metals through a mutual fund structure. Investors unfamiliar with the underlying instruments can first understand what gold ETFs are before evaluating this type of multi-manager investment.   

Passive or Index Fund of Funds 

These FOFs generally invest in index funds or ETFs that track a particular market index or asset category. They can suit investors who prefer a rules-based approach and want exposure to a basket of securities rather than actively managed portfolios. Investors can also understand how mutual funds compare with ETFs before choosing this structure. 

Taxation of Fund of Funds 

Taxation is one of the areas investors often misunderstand. A fund of funds is not taxed under one universal rule simply because it is an FOF. The applicable tax treatment depends largely on what the scheme holds and whether it qualifies for a particular tax category. 

Before investing, consider these points: 

• Equity-oriented FOFs: If the scheme meets the applicable definition of an equity-oriented fund, the relevant equity mutual fund capital gains rules can apply. The holding period for determining short-term or long-term gains is generally 12 months. 

• Non-equity FOFs: FOFs investing in assets such as gold, overseas funds, or other non-equity-oriented schemes may generally fall under non-equity mutual fund taxation. The applicable holding period and tax rate depend on the prevailing rules. 

• Debt-oriented exposure: Certain debt-oriented mutual fund investments can be subject to special tax treatment, particularly where the scheme falls within the applicable specified mutual fund provisions. 

• Capital gains: The tax calculation can differ based on the nature of the underlying holdings, acquisition date, and holding period. 

For a broader explanation of long-term capital gains, see LTCG tax on mutual funds. Always verify the applicable tax rules for the relevant financial year before investing. 

Advantages of Investing in Fund of Funds 

The advantages of investing in a fund of funds mainly come from convenience and diversification. 

Key benefits include the following: 

• Diversification Through One Folio: A single multi-manager investment can provide exposure to several underlying schemes, asset classes or markets without requiring separate investments in each one. 

• Access to Specialised Exposure: Some FOFs can make categories such as overseas equity or precious metals easier to access through a familiar mutual fund structure. 

• Automatic Rebalancing: Allocation-based multi-manager investments may adjust exposure between underlying asset classes according to the scheme’s stated strategy, reducing the need for investors to rebalance manually. 

• Simplified Tracking: Instead of monitoring multiple fund investments, investors can track the FOF through a single folio and statement. 

• Professional Fund Selection: The FOF’s fund manager decides how the scheme allocates money among its underlying funds, subject to the scheme’s investment mandate. 

Limitations to Weigh 

The convenience of a fund of funds comes with trade-offs. Investors should consider the following limitations before investing: 

• Layered Costs: You may incur the fund’s own expense ratio as well as expenses charged by the underlying funds. This can make the overall cost higher than investing directly in a comparable underlying fund or ETF. 

• Less Control: You generally cannot decide how this multi-manager investment distributes money among its underlying schemes. Your exposure is governed by the fund’s stated strategy and portfolio decisions. 

• Portfolio Overlap: If you already own some of the underlying funds, buying an FOF could duplicate your exposure. This can make your portfolio less diversified than it appears. 

• Tax Differences: The tax treatment of a multi-manager investment may not always match that of holding the same broad exposure through another route. The underlying asset category and applicable tax rules matter. 

• Additional Layer: You are relying on both the fund strategy and the investment decisions of the underlying schemes, creating another layer between you and the ultimate securities. 

How to Choose a Fund of Funds 

Choosing a fund of funds should start with the underlying portfolio, rather than its label. Consider these factors in order: 

• Check What it Actually Holds: Review the underlying mutual funds, ETFs, asset classes, geographical exposure, and allocation limits. This tells you what you are really buying. 

• Assess the Total Expense Ratio: Look beyond the fund’s stated expense ratio and consider the expenses of the underlying schemes as well. The combined cost matters for your net returns. 

• Understand the Tax Treatment: Identify whether the fund’s holdings result in equity-oriented, non-equity, or other applicable tax treatment.  

• Check for Portfolio Overlap: Compare the underlying holdings with those of funds you already own. A multi-manager investment should ideally add useful exposure rather than simply replicate your existing portfolio. 

• Read the Investment Objective: Ensure the scheme’s stated objective, asset allocation and risk profile match your investment goal, time horizon and risk tolerance. 

Conclusion 

A Fund of Funds can simplify investing by offering exposure to multiple mutual funds, ETFs, asset classes or markets through a single investment. However, this convenience comes with additional costs and potential tax considerations. Before investing, assess the FOF’s underlying holdings, expenses, taxation, portfolio overlap and investment objective to ensure it aligns with your goals and risk appetite. If you are exploring mutual fund investing, FatakPay’s mutual fund investment service is coming soon. Find out more about the upcoming service and stay informed about its launch. 

Frequently asked questions  

What is FOF in simple words? 

FOF is a mutual fund that invests in other mutual funds or ETFs instead of directly buying securities. Rather than selecting several schemes yourself, you invest in one multi-manager investment that provides exposure to its underlying funds. The value of your units changes based on the performance and value of those underlying investments. 

What is the meaning of a fund of funds? 

The meaning of fund of funds is a mutual fund structure that invests primarily in units of other mutual funds or ETFs. In practical terms, the investor owns units of the multi-manager investment fund, while the fund invests in other schemes. This creates two investment layers between the investor and the securities ultimately held. 

Is a fund of funds a good investment? 

A fund of funds can be useful when its structure provides suitable diversification, access or convenience at a reasonable overall cost. It is not automatically better than investing directly in an underlying fund. Investors should compare its holdings, combined expenses, tax treatment, portfolio overlap, risk and investment objective with available alternatives. 

Do fund of funds charge double expense ratio? 

A fund of funds can involve two layers of expenses, but that does not simply mean one identical expense ratio is charged twice. The fund has its own expenses, while the underlying mutual funds or ETFs may also incur expenses. Investors should therefore assess the total cost of both layers before investing. 

How is a fund of funds taxed in India? 

A fund of funds is taxed based on the nature of its holdings and the applicable tax rules, rather than simply because it is a multi-manager investment. Equity-oriented funds can have different treatment from gold, international or debt-oriented funds. Holding period, acquisition date and the scheme’s classification can also affect the tax outcome. 

What is the difference between a fund of funds and a multi-asset fund? 

A fund of funds describes how a scheme invests, while a multi-asset fund describes the types of assets it aims to hold. An FOF invests through other funds or ETFs. A multi-asset strategy seeks exposure to multiple asset classes, which may be achieved directly or through underlying funds depending on the scheme.