Advantages & Disadvantages of FoFs

What are the advantages and disadvantages of investing in Fund of Funds? Why don't these funds invest in other company's funds?
-G.V. Pandhi

Fund of Funds (FoF) offer you two distinct advantages over investing in the underlying mutual funds yourself. These are tax benefits and convenience. As a FoF is a mutual fund scheme it does not have to any tax on the income generated from buying and selling securities.

Specifically in the context of a fund of funds there will be not tax implications when the fund rebalances to maintain its asset allocation. If you as an investor rebalance your portfolio you are liable to pay capital gains tax. Rebalancing within a period of one year from investing invites short-term capital gains tax, which is 10 per cent for equity funds and gets added to your income for debt funds.

Long term capital gains tax is not payable for equity funds but can be 10 or 20 per cent for debt funds depending on which method you choose. As was the case with equity funds also earlier, you can choose either 10 per cent with inflation indexation or 20 per cent without indexation. The second benefit is in terms of convenience. You do not have to take the decision of selling units and execute the transactions.

For these benefits funds can charge an additional expense of 0.75 per cent and this will take the maximum total expense of a FoF scheme to 3.25 percent. Currently, FoFs are not charging this fee but there is nothing to stop them from doing so in future. If you desire to set up a portfolio consisting of the schemes within individual fund house then a FoF scheme has its benefits. While most FoFs invest only in funds of their own AMCs, Kotak Mutual Fund has an FoF (Kotak Equity FoF) which also invests in other AMC's funds. Currently, only about 25 per cent of its assets are invested in Kotak's own funds.

This article was originally published on February 23, 2005.