'First-time investors, busy professionals, NRIs and those with modest sums looking for curated strategies may find FoFs especially appealing.'
Fund-of-funds (FoFs), once largely focused on debt-plus-arbitrage strategies, are now expanding into diversified equity and hybrid categories.
At least five new equity and multi-asset FoFs are set to launch soon.
So, why the growing interest in this space?
What is a fund-of-funds?
An FoF does not directly invest in stocks or bonds but instead allocates money to other mutual funds.
"Whether it's equity, debt, international funds or even passive strategies -- FoFs bring them all together under one umbrella. It gives you exposure to a wide range of ideas and themes without having to chase them individually," says Nikunj Saraf, CEO, Choice Wealth.
Why the surge in launches?
The surge in FoF launches -- particularly in the equity and hybrid segments --is being driven by two converging factors: Rising investor sophistication and the evolving strategy of fund houses.
"Investors want diversification, expert allocation and access to multiple strategies, but without the hassle of piecemeal investing or constant rebalancing. FoFs offer exactly that--a bundled, expert-managed solution," says Sanjeev Govila, certified financial planner and chief executive officer, Hum Fauji Initiatives.
Investors want simplicity without diluting the strategy.
"Asset management companies are catching on to this shift in investor mindset. Instead of offering yet another plain vanilla equity or debt fund, they're packaging multiple strategies into a single product that feels complete," adds Saraf.
Some fund houses also find it easier to sell new fund offers (NFOs) rather than existing schemes.
"Fund houses have mostly run out of the existing fund categories specified by Sebi. Thematic fund NFOs were popular last year and attracted significant new assets under management," says Vikas V Gupta, CEO and chief investment strategist, Omniscience Capital Advisors.
"Now, FoF is a category that can attract new AUM," adds Gupta.
Diversification benefit
FoFs offer instant diversification by spreading your investment across multiple mutual funds.
"These funds are often managed by different teams with varied philosophies.
"Investors also benefit from consolidated rebalancing, tactical allocation shifts and exposure to global or thematic opportunities that might be tough to access otherwise," says Govila.
Saraf adds that retail investors do not have to stress about which funds to pick, as professionals take that decision on their behalf.
Gupta highlights that FoFs are likely to be less volatile, especially if they invest across multiple asset classes.
Costs and overlaps a concern
Their biggest drawback is cost.
Since an FoF invests in other mutual funds, the expense ratio includes both its own fees and those of the underlying funds.
Such double-layered costs can eat into returns.
"Investors pay not one but two sets of fees--one at the FoF level and another at the underlying fund level," says Saraf.
Sometimes the diversification may be less effective than it appears: two underlying funds might hold similar stocks.
Another risk is over-diversification, where excessive spread dilutes impact.
Taxation can also be tricky.
"Even if the underlying fund is equity-oriented, a fund-of-funds is not directly classified as an equity fund unless it meets the 90 per cent criteria under Section 112A. Otherwise, it is taxed as a debt fund," says Naitik Doshi, director, Nangia Andersen.
Who should invest?
FoFs work well for those who want diversified exposure and professional oversight, but prefer a hands-off approach.
"First-time investors, busy professionals, non-resident Indians and those with modest sums looking for curated strategies may find FoFs especially appealing," says Govila.
Saraf says they work well for those who want to delegate fund selection and rebalancing to experts.
"Investors who don't have trusted advisers or mutual fund distributors and don't have the time, resources or understanding to allocate across funds or asset classes over time, should also consider them," says Gupta.
Even seasoned investors can consider FoFs.
"In particular, those seeking international exposure may go for them, as most global mutual fund options in India are offered through the FoF route," says Anand K Rathi, co-founder, MIRA Money.
Who should avoid them?
Experienced investors who prefer building and managing their own portfolios may find FoFs too restrictive.
"If you are cost-conscious, want full control over fund selection, or already have a well-balanced portfolio, adding an FoF may bring more duplication than value," says Govila.
Adding an FoF to an existing portfolio can also make it difficult to control its asset allocation.
Saraf adds that investors particular about tax efficiency might want to consider other options.
Gupta says that sophisticated investors and those with access to good advisers or wealth managers need not opt for FoFs. Investors seeking aggressive growth may also find them misaligned with their financial goals.
Key checks before investing
Assess the quality and consistency of the underlying schemes.
"Are they top-quartile, benchmark-beating funds, or just average names bundled together?" says Govila.
Understand the fund's asset allocation model.
"Is it static or dynamic? Also assess whether it aligns with your risk profile," says Govila.
Avoid FoFs that merely mimic your existing portfolio and offer no additional diversification.
Understand the fund manager's philosophy and track record across market cycles. Also, review the total expense ratio.
Know the type of funds the FoF invests in.
"Is it a mix of equity and debt? Are the funds domestic, global or both?" says Saraf.
Gupta stresses the importance of checking whether the FoF allows investment across different fund houses or restricts it to its own AMC.
How are FoFs taxed?
Equity FoF
Equity-oriented FoF classified as equity fund if it meets 90 per cent criteria under Section 112A
At least 90 per cent of FoF's investments (by value) must be in units of equity-oriented MFs (with at least 65 per cent investment in equity shares of domestic companies)
Debt FoF
Gains added to income, taxed at slab rates
Hybrid FoF
≥65 per cent equity: equity taxation (12.5% LTCG above Rs 1.25 lakh; 20% STCG; 12-month holding)
≤35 per cent equity: debt tax (slab rate; no holding period benefit)
35–65 per cent equity: 12.5% LTCG; STCG at slab rate; 24-month holding
Source: Nangia Andersen LLP
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