Here is what you need to know before investing in FOF this Diwali

This Diwali, you might be receiving some bonuses. Well, let’s invest and grow it. There are many categories of mutual funds, from equity to debt & hybrid.

But there is one more category that invests in other funds/mutual funds schemes. These funds are known as Fund of Funds (FoFs)

Important points before investing in FOF this Diwali

1. Types of FoFs

Fund of Funds (FoFs) not only invest in international funds but also invest in domestic funds. Below are some categories of funds available in India for investment.

1. International FoFs: These funds invest your money in mutual funds schemes offered by foreign companies. For example, Franklin India Feeder Franklin US Opportunities Direct-Fund Growth. This fund invests in Franklin U. S. Opportunities Fund, an overseas Franklin Templeton mutual fund that invests in securities in the United States of America.
2. ETF FoFs: These funds invest your money in ETFs (Exchange Traded Funds). An ETF invests in the Index of stocks, bonds, commodities and gold. To match the performance of the Index, subject to tracking error. For example, Motilal Oswal Nasdaq 100 FoF. This fund invests in units of Motilal Nasdaq 100 ETF, which invest in companies of Nasdaq 100 in the same proportion, to deliver index-like returns, subject to tracking error.
3. Gold FoFs: These funds primarily invest in gold funds and can also invest in gold or stocks of companies involved in gold mining. For example, Axis Gold Fund and Kotak Gold Fund.
4. Asset Allocation FoFs: These funds invest in multi-asset classes like equity, debt, gold and commodities, etc. For example, ICICI Prudential Asset Allocator Fund (FoF) Direct Plan-Growth.

2. High expense ratio

These categories of funds can charge a high expense ratio as the expenditure on these funds could be high, which is charged in the form of an expense ratio from the investors. One should always look for the expense ratio charges by the fund.

3. Offers diversification

These funds offer good diversification. Diversification can be in multiple funds or multiple asset classes, etc.

But sometimes, investing in these funds could lead to over-diversification of the portfolio, which might hamper the portfolio’s performance. 

4. Moderately risky

With the quality of diversification, the fund’s risk falls under the moderate risk category. As these funds invest in multiple funds, the fund’s risk is balanced out.

Let’s say, in the case of multi-asset fof, if one asset class underperformed but another asset class outperformed, then the overall portfolio balanced out.

5. Taxation

FoFs are considered debt funds, irrespective of the type of funds they invest in. 

If you sell FoF mutual fund units before 3 years from the date of investment, then it will be treated as Short-Term Capital Gain (STCG) and will be taxed as per your income tax slab.

If you sell FoF mutual fund units after 3 years from the date of investment, then it will be treated as Long-Term Capital Gain (LTCG) and will be taxed at 20% flat with the benefit of indexation.

Conclusion

Before investing in FoFs, always first look for the holdings in which the fund is investing and then other factors that we discussed in this blog.

You can also download the EduFund app. Check your risk appetite and invest accordingly.