Fund of Funds (FoFs) is a mutual fund scheme, which invest in the scheme of same mutual funds, instead of investing in securities. These funds can invest in equity oriented, debt oriented and liquid schemes or sector specific schemes. Depending on the investment style of the fund managers, fund of funds schemes can be broadly classified into:
Sector specific funds:such type of Funds invest in different sectors of the economy and thus hedge themselves against the under performance of any sector by taking the advantage from the rise in another sector.
Asset allocation funds:These funds diversify investment by holding several different asset classes at the same time. By varying the stocks to bonds proportion, the fund endeavours to endow the investors, with an appropriate assets allocation in different stages of their lives. They are also known as life cycle funds.
The various advantages of fund of funds (FoFs) scheme are given below:
Diversification: As a fund of funds(FoFs) invests in the schemes of other funds, it provides a greater degree of diversification.
Uncomplicated:Instead of investing in different stocks/units of mutual funds and keeping a track record of all of them, it will be much easier to invest in one fund, which in turn invests in other mutual funds.
Cheap: While entering into capital market it is difficult to diversify because of limited funds. But fund of funds (FoFs) provide an opportunity to go for diversification with comparatively limited amounts.
Risks: Investors can trim down the risk by choosing this route. Because of diversification, even if one stock/scheme is not performing well risk level comes down.
Expertise of Various Managers: As in the case of schemes of mutual funds, fund of funds scheme also work under the due diligence of fund manager. This gives schemes additional expertise as compared to other mutual funds schemes. These schemes also provide access to information which may be difficult to obtain for an investor on a case by case basis.
Like various other investment, Fund of Funds (FoFs) scheme also has various disadvantages, which are given below:
Additional Fees: The more diversified the fund is, the greater the likelihood that the investor will incur an incentive fee on one or more of the constituent managers, regardless of overall FoFs performance.
Associated Risks: Risks associated with all the underlying funds get added at this level. Following are the types of risks associated with fund of funds scheme.
- Management Risks:Every fund manager has a particular style of diversification. This diversification style will be in perfect correlation with the number of manager involved. The views of a manager may be altogether different from the market.
- Operational Risks: Due diligence of a scheme in itself give raise to operational Risks. Continuous monitoring is required for knowing about performance of the funds, any possibilities of a fraud, to known about the investment style of the funds and any desirable or undesirable change in it.
- Qualitative Risks: These include Risks associated with the management environment of the fund such as organizational structure, infrastructure, investment process, operational issues etc.
After realising benefits of the Fund of Funds (FoFs) scheme and the potential of Indian mutual Fund industry, SEBI haddecided to allow this scheme.
Regulation in India
The Fund of Funds (FoFs) scheme was introduced in the Indian market by making suitable amendments in SEBI (Mutual Funds) (Amendments) Regulations, 2003.