Finance

Fund of Funds (FOFs)

Fund of Funds (FOFs)

Fund of Funds is a type of pooled investment fund that invests in other funds. Its investment strategy is holding a portfolio filled with other funds instead of directly investing in stocks, bonds, and other securities. It is also known as multi-manager investment. They generally invest in other mutual funds or hedge funds.

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Types of Fund of Funds (FOFs):-

  1. Asset allocation Funds: It normally consists of equity, debt instruments, precious metals, etc. It helps to generate high returns and has a reduced risk level.
  2. Gold Funds: Trading in Gold securities are known as gold Funds. It usually has a portfolio of mutual funds depending on the asset management company. It invests in physical gold.
  3. International Funds of Funds: Funds in foreign countries are the example of international FOFs.It usually gets higher returns through the stocks.
  4. Multi-Manager Funds of funds: This is the most common type of fund. It has a multi portfolio manager, each dealing with the asset present in the mutual fund. It consists of many professional managed funds but has a single portfolio.
  5. ETF FOFs: ETF is also known as Exchange-traded funds.ETF requires a Demat account. It has a higher risk factor as it is traded like shares in the stock market.

Who can Invest in Fund of Funds (FOFs)?

Funds of Funds (FoFs) are generally used by those investors that have limited liability to diversify and have smaller investable assets. They are also used by investors that are not very experienced in choosing mutual funds. People with fewer resources and low liquidity can prefer these funds. The main aim is to have maximum returns by investing in the portfolio with minimal risk, hence smaller investors who want better exposure with fewer risks also use FoFs. It gives smaller investors access to professional management and diversification which tend to be reserved for the wealthy.

Advantages of Fund of Funds

  • Diversification: Fund of Funds has a variety of well-performing funds in their portfolios. Each of these funds is either specializing in a specific asset or sector. Thus, the portfolio is well-diversified and both gains and risks are optimized.
  • Professional management: Funds of Funds are managed by trained professionals who have years of experience. Thus, they take calculated decisions after analyzing the market for the highest yields possible.
  • Low resource requirements: Fund of Funds allows investors who have limited financial resources to invest in top funds and earn high profits. People with limited financial resources can easily invest in these funds to earn high profits. There are monthly investment schemes available for them.

Drawbacks of Fund of Funds:

  • Fees: Fund of Funds charge high management fees for the professional expertise provided. They have a higher expense ratio as compared to regular mutual funds. Like an individual fund, FoFs also charge performance fees, but they are generally lower. The main added expense is choosing the right asset in which they have to invest.
  • Tax: Tax should be paid by the investor. There are certain taxes levied on fund of funds that investors have to pay during redemption. Short-term and long-term capital gains both have to go through tax deductions according to the income of the investors.
  • Choosing managers:  If the FOF is constricted, there is also difficulty in finding qualified managers. Therefore, picking good fund managers and funds can be difficult. The FOF can also end up owning the same stock or other security by several different funds. This can thus reduce potential diversification.

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Bottom Line:

Fund of funds is pooled investment funds that instead of investing in stocks or bonds, invest in other investment funds. This can be great for small investors with lower financial resources to diversify their portfolios and gain access to professional management. However, there are also some fees involved that may reduce the actual profit gained.

Authors – Abha Shetty and Isha Patel

About the Author – Abha is a second-year BMS student and FRM level I candidate. She is very intrigued by the world of financial markets and hopes to master the art of investing and trading.

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