Fund of Funds

A Fund of Funds (FoF) is a mutual fund that invests in other mutual funds. Just as fund invests in stocks or bonds on your behalf, a FoF invests in other mutual fund schemes. So it is a basket of mutual fund schemes that can invest in equity and debt schemes depending on its investment objective.

These can belong to the same mutual funds as the FoF or belong to different mutual fund houses. At present, the FoFs offered in India belong to the same fund house. Just like other mutual fund schemes, an FoF will also have its expenses. Regulations permit an FoF to charge 0.85 per cent as expenses. If this is added to the 2.5 per cent, the maximum expense ratio that an equity fund can charge, then the total cost of this offer can be as high as 3.35 per cent.

Expenses will, however, be the only area where a Fund of Fund will be charging anything extra. Loads will be levied only when the investor buys into an FoF and not when the FoF itself invests in the underlying funds.

One of the biggest advantages of an FoF is that it is very tax friendly from an asset rebalancing point of view. If an investor tries to rebalance his own fund or stock holdings then he is liable to pay the capital gains tax that is applicable. And if the gains are short-term, then the tax can be as high as 30 per cent. But an FoF by virtue of its being a mutual fund scheme is exempt from capital gains tax on its internal transactions. So when an FoF rebalances to maintain its stated allocation between equity and debt there is no element of capital gains tax.

FoFs can also be very convenient to handle as they reduce the number of funds that have to be managed. So there is just one folio and just one NAV to track. With asset rebalancing built into them these funds automatically carry out one of your major responsibilities. That is shifting between equity and debt according to your predecided asset allocation.

At the same time one will have to monitor the performance of the underlying schemes also. If these are not performing then your FoF will go nowhere. While the currently available FoFs specify the schemes they invest in, a situation could also arise where they could change the underlying schemes from time to time. This will call for even more careful examination to check whether the FoF is sticking to its investment objectives or not.

The first FoF to be launched in India is Franklin India Dynamic PE Ratio Fund. This FoF has as its underlying schemes Franklin India Bluechip and Templeton India Income Fund. The fund reallocates between these two schemes on the basis of the PE ratio of the S&P CNX Nifty. This reallocation is done on a monthly basis.

Prudential ICICI is the other fund house, which has launched a FoF. This FoF, known as Pru ICICI Advisor Series, offers five FoFs with varying equity and debt exposure. The range starts with a 'Very Cautious' plan that will have no equity exposure and will invest in cash and money market funds.

At the other extreme there is the 'Very Aggressive' plan that will invest 90 to 100 per cent of its corpus in equity. In between lie the 'Cautious', 'Moderate' and 'Aggressive' plans, each with a larger equity exposure than the preceding fund. All the existing schemes of Prudential ICICI are possible candidates for its FoF plans. Specific funds have not yet been announced by the AMC.

And recently, Birla mutual fund has also launched its FOF called Birla Asset Allocation Fund. The scheme provides four different plans - Aggressive plan, Moderate plan, Conservative plan and Dynamic Debt Plan each having separate asset allocation.

The holy grail of sensible investing is figuring out a good asset allocation and then rebalancing your portfolio dispassionately to stick to your asset allocation. With the advent of FoFs, this task could now be made much easier and of course less taxing.