What is Fund of Funds – Meaning funds of funds, Advantages and Taxation

Published On: 27-Aug-2020

Mutual funds provide the benefit of diversification to the investors by creating a basket of portfolio securities. A Fund of Funds (FoF) goes a step ahead to invest in other mutual fund schemes instead of directly investing in equity, debt securities, etc. 

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What is a Fund of Funds?

As the name suggests, the Fund of Funds (FoF) creates an investment portfolio comprising units of other mutual fund schemes. Such schemes are chosen as per their suitability to the investment objective of the FoF. An FoF may also aim to provide access to the investment options not directly available to the investors, e.g., international equities or ETFs (Exchange Traded Funds).

As of 31st July 2020, the total AUM under Fund of Funds category is Rs. 22,897 crores, with around 80% share of FoFs investing in domestic schemes, while the balance 20% denotes FoFs investing in overseas funds 

Source: Association of Mutual Funds in India – AMFI. 

Note: Data in respect Fund of Funds Domestic is shown for information only. The same is included in the respective underlying schemes.

Advantages of Investing in Fund of Funds

FoFs may have a higher expense ratio indirectly as it bears the expense ratios of the portfolio schemes apart from its expenses. However, the advantages that FoFs bring along tend to compensate the investors suitably. The investors of FoF benefit from the expertise of fund managers managing the FoF and the fund managers managing the scheme in which such FoF has invested. The investors can also reap the benefit of diversification across different fund categories and asset classes through FoFs.

FoFs also enable the access of investors to ETFs, as an investor must have a demat account and a trading account with a stockbroker to invest in ETFs. Further, the liquidity in ETFs is not guaranteed and depends on the demand and supply of ETF units at the stock exchanges. In contrast, the investors are also assured of liquidity in FoF, as the investments happen through mutual fund houses. 

How to Invest in Fund of Funds?

The process of investing in FoF is similar to investing in any other mutual fund scheme. One can submit the application forms at any of the official Point of Acceptance or they can invest online through the website or mobile app. One can hold such units either in investor folios or in a demat account and can also register a Systematic Investment Plan (SIP) to make regular investments. 

Taxation of Fund of Funds

Income tax laws classify mutual funds, including FoFs, into two categories - equity-oriented funds and other than equity-oriented funds. An equity-oriented fund must invest at least 65% in equity and equity-related instruments, but the classification criteria for Fund of Funds are more stringent. FoF can be classified as an equity-oriented fund if it invests at least 90% in Exchange Traded Funds (ETFs), which further invests at least 90% in shares of Indian companies listed on stock exchanges. 

For taxation purposes, all other FoFs are considered ‘other than equity-oriented’ schemes even if they invest 100% of their net assets in another equity fund. 

Here is a summary of taxation applicable for capital gains on FoFs:

Classification of FoF

Holding Period

Capital Gain

Tax Rate

Equity-oriented fund

Less than 12 months

Short Term Capital Gain (STCG)

15%

12 months or more

Long Term Capital Gain (LTCG)

10% after an exemption of Rs. 1 lakh in a year for aggregate LTCG from equities

Other than equity-oriented fund

Less than 36 months

STCG

Regular tax rates

36 months or more

LTCG

20% with indexation

 

Note: The tax provisions, as mentioned in the article, are for illustrative purposes only, and are updated as per the Finance Act 2020. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.