An introduction to Fund of Funds

Ever heard of a fund which is a constituted by other funds?
Well, that’s what is called the fund of funds. In this article, I will aim to provide a tutorial about fund of funds. This will help you understand how fund of funds work and what are the risks associated with investing in fund of funds.

Fund of Funds works like as follows:
A simple mutual fund consists of stocks – which can be as low as 10 stocks or as high as 200 stocks. On the other hand, a Fund of Funds consists of different funds. Hence, as a mutual fund invests in stocks, a fund of fund invests in other funds. It’s a very common concept in the western countries to have fund of funds as investment vehicle. However, no returns are guaranteed.

Say, for example, I am running a fund of funds and I invest in 10 different funds. Ultimately, these 10 different funds will invest in stocks. Hence, there is a major chance that fund 1 and fund 2 are holding the same stocks. Hence I end up paying more fund management charges, entry, exit loads and commissions for ultimately holding the same stocks.

One good option to get rid of the problem is to diversify. Say I may be investing in a fund that holds only Oil stocks. And second fund that I can choose that invests only in metal stocks. But the problem is again of the charges that I pay for holding so many funds.

Another problem is that most of the funds are not sector specific. They may keep switching their holdings as per the will and wish of the fund manager. Hence, I may not be able to track when the two funds have overlapping stock holdings.

Anyways, it’s a good option for investment if you can find specific and strictly sector specific funds, like the Oil company funds. In the developed countries of the west, we can find a lot of such funds. These funds are quite common among investors.

Unfortunately, in India, we do not see any such fund of funds. However, it is easy to create these fund of funds on your own. Simply buy the sector specific funds you like and you will have a fund of funds of your choice. But be careful, about the precise diversification and sector specific funds.

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