What Is a Fund of Funds?
A fund of funds (often shortened to FoF) is a mutual fund that invests in other mutual funds instead of buying individual stocks or bonds directly. Instead of owning shares of, say, a specific company, you’re owning units of a fund that itself owns units of several other funds.
Think of it as a layer added on top of regular investing. You invest once, and the fund manager decides which underlying funds to hold and in what proportions, giving you exposure to multiple funds through a single investment.
How Does a Fund of Funds Work?
When you invest in a fund of funds, your money doesn’t go directly into stocks or bonds. Instead, it’s used to buy units of other mutual funds, which are chosen and managed by the fund of funds’ manager based on the scheme’s stated strategy.
For example, a fund of funds might hold:
- A domestic large-cap stock fund
- An international equity fund
- A bond fund
- A gold or commodity fund
The specific mix depends on the fund’s goal. Some are built for broad diversification, some focus on international investing that might otherwise be hard for an individual to access directly, and some are built around a specific theme, like sustainable investing across multiple fund managers.
Why Do Fund of Funds Exist?
Fund of funds structures exist mainly to simplify access to diversification that would otherwise require you to research, buy, and manage several separate funds yourself. In practice, this appeals to investors who want broad exposure without the ongoing work of picking and monitoring multiple individual funds.
They’re also commonly used for international investing, since directly buying foreign mutual funds can sometimes be complicated or restricted for regular investors, while a domestically available fund of funds can offer that international exposure more simply.
Fund of Funds vs. a Regular Mutual Fund
| Feature | Regular Mutual Fund | Fund of Funds |
|---|---|---|
| What it invests in | Stocks, bonds, or other securities directly | Units of other mutual funds |
| Layers of management | One layer of management | Two layers (the FoF manager and each underlying fund’s manager) |
| Diversification | Depends on the fund’s holdings | Often broader, since it spans multiple funds |
| Cost structure | Single expense ratio | Can include the FoF’s expense ratio plus the underlying funds’ fees |
| Complexity for investor | Simple, single strategy | Simple to invest in, but underlying structure is more layered |
Advantages of a Fund of Funds
- Simplified diversification: One purchase can give you exposure to several different funds and strategies.
- Access to hard-to-reach markets: Useful for gaining international or specialized exposure that might be difficult to access directly.
- Professional selection: The fund manager handles choosing and monitoring the underlying funds, saving you the research effort.
- Convenient for a single SIP: You can set up one systematic investment plan and get broad exposure, rather than managing several separate SIPs.
Drawbacks to Be Aware Of
- Layered costs: Because you’re paying for both the fund of funds’ management and the fees of the underlying funds, the combined cost can sometimes be higher than investing directly in individual funds.
- Less transparency at a glance: You need to dig a bit deeper to see exactly what you’re invested in, since your fact sheet shows fund holdings rather than individual stocks or bonds directly.
- Performance depends on manager choices at two levels: Both the fund of funds’ selection decisions and the performance of each underlying fund affect your returns.
- Possible overlap: If you already hold some of the underlying funds separately, a fund of funds could create unintentional duplication in your portfolio.
Who Should Consider a Fund of Funds?
A fund of funds can be a reasonable choice if you:
- Want broad diversification without managing several individual fund investments
- Are interested in international or specialized exposure that’s hard to access directly
- Prefer a simpler, more hands-off approach to spreading your investments
It may be less suitable if you’re cost-sensitive and want to minimize layered fees, or if you’d rather build and control your own mix of individual funds directly.
What to Check Before Investing in a Fund of Funds
- Total cost, including both the fund of funds’ own expense ratio and the weighted cost of its underlying funds
- What it actually invests in, by reviewing the list of underlying funds and their respective strategies
- Whether it overlaps with mutual funds you already hold
- The track record of the fund of funds itself, not just the underlying funds it holds
Key Takeaways
- A fund of funds invests in other mutual funds rather than buying stocks or bonds directly.
- It offers simplified access to diversification, including international or specialized exposure that can be harder to reach directly.
- Costs can be layered, combining the fund of funds’ fees with those of the underlying funds, so total cost deserves a close look.
- It suits investors who want broad, hands-off diversification through a single investment.
- Always check for overlap with funds you already own before adding a fund of funds to your portfolio.
Frequently Asked Questions
Is a fund of funds riskier than a regular mutual fund?
Not inherently. Its risk level depends on what the underlying funds invest in. A fund of funds holding mostly equity funds carries similar risk to a direct equity fund, while one focused on bonds would be comparatively lower risk.
Are fees higher in a fund of funds compared to a regular mutual fund?
Often, yes, since you may be paying for two layers of management: the fund of funds itself and the underlying funds it invests in. It’s worth comparing the total combined cost against similar direct investment options.
Can a fund of funds invest in international mutual funds?
Yes, this is one of the most common uses of the fund of funds structure, giving investors a simpler path to international exposure without buying foreign funds directly.
How is a fund of funds different from an index fund?
An index fund tracks a specific market index by holding the underlying securities directly. A fund of funds invests in other mutual funds, which may or may not include index funds among its holdings.
Should a beginner start with a fund of funds or a regular diversified fund?
Either can work depending on your goals. A regular diversified equity fund is often a simpler, lower-cost starting point, while a fund of funds might suit someone specifically seeking international exposure or extra diversification in one step.
