Read on to know the meaning of FoFs and when should you consider investing in them
What is the advantage of a fund of funds? - Ravindranath Ganesh
A fund of funds (FoF) is a type of mutual fund scheme that invests in other mutual funds. Just as a fund invests in stocks or bonds on your behalf, an FoF invests in other mutual fund schemes. They invest in equity and debt instruments in one or more than one scheme depending on their investment objective.
Often fund houses launch an FoF variant for their ETFs (exchange-traded funds). ETFs are traded on stock exchanges just like stocks and one needs a demat and a trading account to invest in them. However, through their FoF variant, investors can invest in these ETFs even without a demat account. FoFs function exactly like mutual funds and you can even invest in them through SIPs which is not possible in ETFs.
Likewise, there are FoFs that invest in overseas mutual funds or indices. While we do have actively managed international funds, most schemes in the category are FoFs which further invest the money in an overseas mutual fund or an international index.
However, one must note that like other mutual fund schemes, FoFs too have their own expense ratio. So the investor has to ultimately bear the expense of two funds. One of the FoF and the other of the underlying fund. So let's say the expense of a fund of funds is 0.50 per cent and that of the underlying fund is 1 per cent. So the total expense that an investor would have to bear is 1.50 per cent.
Considering the same, it may be beneficial to invest in an FoF only when it isn't possible for you to invest in the underlying fund, or the process is too complicated. For instance, when you want exposure in an internationally managed fund for which an FoF is available or you don't have a demat account but want to invest in an ETF with its FoF variant.
When it comes to taxation, FoFs are taxed as a non-equity fund. If you redeem your investments within three years, the gains are termed as short-term capital gains and they are added to your taxable income and taxed as per the income tax slab. If you redeem after three years, the gains are termed as long-term capital gains and are taxed at 20 per cent with the benefits of indexation. However, FoFs investing more than 90 per cent in domestic equity ETFs are taxed as per an equity fund.
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