What Is a Fund of Funds? Meaning, Structure & Types

Investors today have access to a wide range of mutual fund products. Among them, the Fund of Funds (FoF) stands out as a diversified investment vehicle that invests not directly in stocks or bonds, but in other mutual funds or exchange-traded funds.

For investors looking for diversification across fund managers, asset classes, or even global markets, understanding what is a fund of funds becomes important. This article explains how a Fund of Funds scheme works, its types, advantages, taxation, and how it differs from ETFs.

What Is a Fund of Funds?

A Fund of Funds is a mutual fund that invests in other mutual fund schemes instead of investing directly in individual securities such as stocks or bonds.

In simple terms, if a regular mutual fund buys shares of companies, a Fund of Funds buys units of other mutual funds. This structure allows investors to gain exposure to multiple strategies through a single investment.

If you are wondering what is a fund of funds, think of it as a “mutual fund that invests in mutual funds.”

How Does a Fund of Funds Scheme Work?

A fund of funds scheme pools money from investors and allocates it across different underlying funds based on its investment objective.

For example:

• A global FoF may invest in international equity funds

• A gold FoF may invest in gold ETFs

• A multi-asset FoF may invest in equity, debt, and commodity funds

The fund manager decides:

• Which underlying funds to invest in

• How much allocation to assign

• When to rebalance

This layered structure provides diversification across fund houses, strategies, and asset classes.

Types of Fund of Funds

There are several types of Fund of Funds available in India:

1. Domestic Fund of Funds

Invests in mutual funds that operate within India.

2. International Fund of Funds

Provides exposure to global markets by investing in overseas mutual funds or ETFs.

3. ETF-based Fund of Funds

Invests primarily in exchange-traded funds, including gold and index ETFs.

4. Asset Allocation or Multi Strategy Funds

These funds allocate investments across equity, debt, and other asset classes through different underlying schemes. Many investors associate such structures with multi strategy funds, which aim to diversify across strategies.

5. Thematic or Sector FoFs

Invest in funds focused on specific sectors like technology or healthcare.

Each type serves different investor objectives depending on risk appetite and geographic preference.

Advantages of Fund of Funds

There are several advantages of fund of funds that make them attractive to certain investors:

Diversification

Exposure to multiple funds reduces concentration risk.

Professional Allocation

Asset allocation decisions are handled by experienced fund managers.

Access to Global Markets

International FoFs provide easy overseas exposure without opening foreign accounts.

Convenience

Investors manage one fund instead of multiple schemes.

Lower Entry Barrier

Some international or thematic exposure can be accessed with relatively small investments.

Risks and Limitations of Fund of Funds

Despite the benefits, FoFs also have certain drawbacks:

Double Layer of Expenses

Since the FoF invests in other funds, investors indirectly bear expenses of both layers.

Tax Inefficiency

Many FoFs are taxed as debt funds, even if underlying exposure is equity-heavy.

Limited Control

Investors cannot customise allocation across underlying funds.

Performance Dependence

Returns depend on both the FoF manager and the performance of underlying funds.

Understanding these risks is essential before investing.

Difference Between FoF and ETF

Investors often ask about the difference between FoF and ETF.

While ETFs are cost-efficient and transparent, FoFs offer convenience and active allocation.

Taxation of Fund of Funds in India

In India, taxation depends on the classification of the FoF.

Most Fund of Funds (except those investing predominantly in domestic equity funds) are treated as non-equity funds for taxation purposes.

• Gains are taxed as per the investor’s income tax slab

• Tax applies upon redemption

• No indexation benefit under current rules

International FoFs are also taxed as debt-oriented funds, even if the underlying exposure is equity-based.

Investors should consider post-tax returns while evaluating FoFs.

Who Should Invest in a Fund of Funds?

A Fund of Funds may be suitable for:

• Investors seeking international diversification

• Those preferring simplified asset allocation

• Beginners who want diversified exposure through one scheme

• Investors looking for thematic or multi-asset exposure

However, experienced investors comfortable building portfolios directly may prefer selecting individual funds.

Are Fund of Funds Better Than Direct Mutual Funds?

The answer depends on the investor’s needs.

FoFs may be better if:

• You want global exposure easily

• You prefer hands-off allocation

• You seek multi-strategy diversification

Direct mutual funds may be better if:

• You want lower expense ratios

• You prefer customized allocation

• You are comfortable monitoring multiple schemes

There is no universal winner—investment suitability varies by goal and expertise.

Conclusion

A Fund of Funds offers diversification by investing in multiple mutual fund schemes within a single structure. It simplifies asset allocation, provides global exposure, and offers convenience to investors who prefer a consolidated approach.

However, factors such as layered costs, taxation, and performance dependency must be carefully evaluated. Before investing, investors should assess their financial goals, time horizon, and risk appetite.

Understanding what is a fund of funds and how it compares to ETFs or direct mutual funds helps in making informed and goal-aligned investment decisions.