Fund of Funds (FoFs): Meaning, Types, and Advantages

What Is a Fund of Funds (FoFs)?

Fund of Funds (FoF), a mutual fund scheme, allocates its capital in other mutual funds, ETFs, or hedge funds, instead of investing directly into stocks or bonds. These funds help to spread risks across various markets and asset classes, with benefits from professional fund management.

An FoF is essentially described as a “fund made up of funds”. where the fund manager accumulated capital from the investors and then distributed it across multiple underlying schemes managed by different fund managers. This approach provides a balanced portfolio managed by experts.

How Funds of Funds Work?

The points below discuss the working of FoFs:

• Aggregating capital: An FoF collects money from multiple investors and combines the capital, which is later invested across several funds.
• Selection of funds: The FoF manager next chooses funds based on past performance, risk levels, fund strategy, and the track record of the fund managers. 
• Diversification across strategies: By investing in different types of funds, an FoF spreads the risk across assets and investment styles, which reduces the impact of volatility from any single fund.
• Active and passive allocation: Some FoFs invest in actively managed funds, while others allocate to index funds or ETFs. Even in passive FoFs, the manager decides which funds to include based on the overall investment objective.
• Layered fee structure: In FoF investment, investors are charged fees at two levels, one charged by the FoF itself and another by the funds. 

Let us say, you invested ₹10,000 into a Fund of Funds (FoF) that charges a 1.00% management fee, while the other funds together charge 2.00%. The FoF fee would be ₹100. The remaining ₹9,900 is then invested, again, on which a 2% charge amounts to ₹198. In total, you pay ₹298 annually in fees, showing how costs are applied at two levels.

Types of Funds of Funds

Fund of Funds (FoFs) are available in multiple forms, and each of these is built around different investment goals, risk levels, and investor preferences. They are usually grouped based on the kind of funds they invest in, such as hedge funds, mutual funds, private equity, real estate, or commodities. 

The table below outlines the main types of FoFs. Additionally, before investing, it is important to review aspects such as the fund’s approach, the experience of its managers, the fee structure, liquidity, and the overall risks involved.

Funds of Funds Type	Description	Target Investor
Multi-Manager Funds	Invest across a mix of asset classes and fund managers, including equity, debt, and alternatives, to create a diversified portfolio	Institutional investors, High-Net-Worth-Individuals seeking diversification
Funds of Hedge Funds	Allocate capital primarily to hedge funds following specialised strategies such as global macro or long-short equity	Sophisticated investors having high risk tolerance
Funds of Mutual Funds	Invest in a basket of mutual funds across equity, debt, or hybrid categories for balanced exposure	Retail investors looking for diversification through a single investment
ETFs of ETFs	It is an ETF fund that invests in multiple other ETFs to build a diversified, low-cost portfolio aligned with index strategies	Investors preferring passive, low-cost allocation
Private Equity FoFs	This fund invests into several private equity funds, covering strategies such as buyouts and venture capital	Institutional investors and HNWIs
Real Estate FoFs	Invest in funds focused on real estate assets or REITs instead of direct property ownership	Investors seeking real estate exposure without direct ownership
Infrastructure FoFs	Allocate capital to funds investing in infrastructure projects such as energy, transport, and utilities	Long-term investors such as pension funds
Commodity FoFs	Invest in funds linked to commodities such as metals, energy, or agriculture to diversify portfolios	Investors hedging against inflation or market cycles
Debt FoFs	Focus on investing in debt-oriented funds such as corporate bonds or government securities	Investors seeking stable income with lower volatility

Advantages of Investing in a FoFs

Investing in FoFs can provide multiple advantages, which are as follows:

• Built-in diversification: By investing across several other funds, an FoF spreads the risk over different asset classes, sectors, and strategies, which reduces the dependence on a single investment.
• Professional fund selection: Investors rely on experienced managers who assess and select funds based on performance, strategy, and risk, while removing the need for individual research.
• Access to wider markets: FoFs can provide entry into global markets, alternative assets, or specialised strategies that may not be easily available to individual investors.
• Simplified portfolio management: Instead of tracking multiple investments, investors hold a single fund that manages allocation and rebalancing on their behalf.

Disadvantages of Investing in a FoFs

However, the added layer of structure in a Fund of Funds (FoF) also brings certain limitations that investors should consider before allocation.

• Double layer of costs: Investors pay a management fee for the FoF, along with the expense ratios of the funds under the scheme, which reduces net returns over time.
• Higher expense ratios: Since FoFs invest in other funds, their total expense ratio is usually higher than that of direct mutual fund investments.
• Unfavourable tax treatment: FoFs are taxed as debt funds rather than equity funds, even if the underlying investments are equity-oriented, which can lower post-tax returns.
• Limited transparency: The multiple layers of investments can make it harder to track individual holdings and strategies for the investors, leaving less clarity on where their money is deployed.

Multi-Strategy Funds (MSFs) vs. FoFs

As investors evaluate Fund of Funds (FoF), comparing it with multi-strategy funds will further help in clarifying differences in structure, cost, and portfolio management approach.

Basis	Multi-Strategy Funds (MSFs)	Funds of Funds (FoFs)
Structure	Managed by a single fund manager who oversees multiple investment strategies within one fund	Invests in multiple mutual funds, each managed by different fund managers
Management approach	One manager coordinates various strategies, often supported by a team of specialists	Allocation decisions are made at the FoF level, while funds follow their own strategies
Diversification style	Diversification comes from different strategies within the same fund	Diversification comes from investing across multiple funds and managers
Control and flexibility	Centralised control allows quicker shifts between strategies based on market conditions	Less direct control, as changes depend on the performance and strategy of funds
Cost structure	Typically, lower fees compared to FoFs, as there is only one layer of management	Higher costs due to fees at both the FoF level and the underlying fund level
Manager risk	Depends heavily on the capability of a single manager and their team to handle multiple strategies	Spreads manager risk across several fund managers
Transparency	Generally clearer, as investments are managed within one structure	Can be less transparent due to multiple layers of funds
Suitable for	Investors seeking diversification under one manager with relatively lower costs	Investors preferring diversification across multiple managers, even with higher fees

Who Should Invest in FoFs?

In practice, a Fund of Funds (FoF) is designed for investors who value simplicity, diversification, and professional allocation. It suits those who prefer a managed approach over active fund selection.

• Beginner investors: Those new to investing, who may not have the experience or confidence to select and monitor individual mutual funds.
• Investors with limited capital: It allows participation in a diversified portfolio of funds with a relatively smaller investment amount.
• Time-constrained individuals: It can be suitable for those who cannot regularly track, review, or rebalance a portfolio of multiple funds.
• Investors with international interest: It provides access to global markets or specialised sectors without the need to open and manage overseas investment accounts.

How to Invest in FoFs?

Here is a guide to investing in FoFs:

Step–1	Select the right FoF	Choose a fund that matches your investment objective, along with your risk tolerance.
Step–2	Complete KYC	Finish the KYC process using PAN and Aadhaar to become eligible for investing.
Step–3	Choose investment method	Invest directly through the AMC’s website or app to avoid commissions, or use online brokerage platforms.
Step–4	Select investment type	Opt for an SIP for regular investing or a lumpsum approach if investing a larger amount at once.
Step–5	Complete the purchase	Decide the investment amount or number of units and make the payment through your linked bank account.

Conclusion

A Fund of Funds (FoF) is a method of investing that involves diversification without managing multiple investments separately. Investing across various funds brings together different strategies and asset classes within a single portfolio. 

However, you must understand the impact of the added layer of costs and taxation. With this, if you prefer simplicity and professional allocation, FoFs can form a practical part of a long-term investment approach.

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