A fund of funds (FOF), also known as a multi-manager investment, is an investment product comprised of different mutual funds. In simple terms, it basically means a mutual fund for mutual funds. The FOF strategy intends to accomplish appropriate asset allocation with investments in an assortment of asset classes that are all wrapped into one portfolio.
Often, they are used by investors who have restricted capacity to diversify, or who do not want to invest in specific mutual funds due to lower risk tolerance. In short, FOF provides professional management along with diversification.
There are different types of FOFs with each acting on a different investment scheme. The fund of funds may be structured as a mutual fund, a hedge fund, a private equity fund, or an investment trust. It may be fettered which means it only invests in portfolios managed by one investment company; or unfettered, which means letting it invest in external funds controlled by other managers from other firms.
WHAT ARE THE ADVANTAGES?
Diversification: FOFs aim at different best-performing mutual funds in the market, each specializing in a particular asset or sector of the fund. This helps to secure profits through diversification as both returns, as well as risks, are optimized because of the underlying variation in the portfolio.
Better risk management: FOF targets at spreading out risk. Owning one mutual fund reduces risk by owning several stocks, however FOF depletes down the risk to bare minimum by spreading the risk across thousands of stocks contained in the mutual funds. It also gives the chance to diminish the risk of investing with a single fund manager.
A small investment can reach more asset classes: The idea of FOF works best in the case of proper allocation of funds, which means creating a portfolio that is a mix of equity, debt, gold, and liquid funds, especially when you are planning your long-term goals. It helps to combine different asset classes with similar risk and return profiles. With small amounts of investment, one can easily get access to equities, debt, liquid funds, gold, commodities, international indices, and almost every conceivable asset class available. One just has to invest in a single FOF with a single NAV and their long-term goals are taken care of.
Exposure to ETF without holding a Demat account: To transact in ETFs (exchange-traded funds), a basket of securities, shares of which are sold on an exchange, one needs broking and Demat accounts. However, the FOF route provides the benefit of purchasing ETF without any Demat account. It buys the units of the feeder ETF.
WHO SHOULD INVEST IN A FUND OF FUNDS?
FOFs are one of the most appropriate routes for people who are risk averse. The fundamental objective of it is to augment returns by putting resources into a varied portfolio, presenting insignificant risk. People with admittance to fewer financial resources which they can save for a more broadened timeframe can pick such types of mutual funds. Preferably, financial investors with relatively fewer assets and low liquidity needs can decide to put resources into the top fund of funds available in the market. This empowers them to acquire extreme returns at insignificant risk.
For those who possess a low-risk appetite, investing in FOFs can indeed be a smart, safe & practical choice to make as it allows an investor to invest in a diversified portfolio and in the long haul helps in generating better risk-adjusted returns.
The author, Palka A Chopra, is Senior Vice President at Master Capital Services. The views expressed are personal
First Published: IST