Fund of Funds (FOF): Meaning, Types and Taxation

Important Keyword: Fund of Funds, Income Tax.

Fund of Funds (FOF): Meaning, Types and Taxation

A Fund of Funds (FoF) represents a distinct approach in the realm of mutual funds. Rather than directly venturing into individual stocks, bonds, or other securities, it channels investments into a diversified portfolio of other mutual funds. In simpler terms, it’s like a fund that invests in a basket of mutual funds instead of individual assets. This strategy offers investors a convenient way to access diversified exposure across various market segments through a single investment vehicle.

Fund of Funds (FOF): Meaning

A fund of fund, also known as a multi-manager investment, represents a collective investment pool that directs its investments into various types of funds.

Investment Approach: Fund managers of FoFs adopt a strategy of selecting a combination of mutual funds across different asset classes such as equity, debt, and hybrid, aligning with the investment objectives of the FoF.

Diversification: By spreading investments across multiple mutual funds spanning different asset classes, FoFs offer investors a robust level of diversification within a single investment entity.

Professional Oversight: Managed by seasoned fund managers, FoFs benefit from expert decision-making regarding asset allocation, fund selection, and rebalancing, all guided by prevailing market conditions and investment goals.

These mutual funds can encompass investments in both domestic and international funds.

Taxation of Fund of Funds (FoF):

The tax classification of FoFs follows specific criteria. If a FoF allocates at least 90% of its funds into equity-oriented funds, with these funds further investing at least 90% of their assets in shares of Indian companies traded on stock exchanges, it is categorized as an equity-oriented fund. However, if a FoF invests its entire net assets in other equity funds, all other FoFs are taxed as debt schemes or non-equity-oriented schemes.

For FoFs classified as equity funds, Short Term Capital Gains (STCG) are taxed at 15% for investments sold within one year of purchase, while Long Term Capital Gains (LTCG) are taxed at 10% for profits exceeding Rs 1,00,000 and sold after one year of investment.

However, when a FoF is classified as a debt fund, the Capital gains will be taxed at the slab rates.

Fund of Funds (FOF): Types

Asset Allocation Funds

Asset allocators, or multi-asset funds, represent a diversified investment approach that spans various asset classes such as equities, debt, and commodities like gold. For instance, Fund of Funds (FoFs) could allocate investments across different mutual fund schemes focusing on stocks, bonds, and gold. This strategy aims to mitigate portfolio risk while potentially enhancing returns through diversification.

Gold Funds:

Gold funds within the FoF invest primarily in funds dealing with gold securities. Depending on the asset management company, these FoFs may invest in gold mutual funds or directly in gold trading companies. For instance, the ICICI Prudential Regular Gold Savings Fund (FOF) invests in ICICI Prudential Gold ETF.

International Fund of Funds:

International FoFs invest in funds operating in foreign countries, offering investors exposure to potentially higher returns from the best-performing stocks and bonds across different nations. Fund managers of international FoFs can leverage the expertise of foreign fund managers experienced in investing in specific countries’ securities.

Multi-Manager Fund of Funds:

Multi-manager FoFs are a common type that includes various professionally managed mutual funds with different portfolio concentrations. This approach provides investors with access to a diversified pool of funds managed by different investment professionals.

ETF Fund of Funds:

ETF FoFs invest in shares traded on the stock market, presenting higher risk due to market fluctuations. Unlike direct ETF investments requiring a Demat account, FoFs offer accessibility without such limitations.

Advantages of FOF:

FOFs offer several advantages, including diversification, professional management, accessibility, better risk management, and tailored investment strategies. These features contribute to potentially enhancing investment outcomes while managing risk effectively.

Limitations of FOF:

Despite their benefits, investing in FOFs has limitations such as higher expense ratios charged by fund houses for managing investments, the possibility of portfolio duplication across multiple funds, and lack of flexibility for investors to choose underlying assets. Once invested, investors cannot alter the asset allocation according to changing market conditions or preferences.

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Official Income Tax Return filing website: https://incometaxindia.gov.in/