Use fund of funds to diversify investments faster and better

Tags: Mutual Funds

An ideal FoF is one that invests across schemes of multiple MFs

Consider this: if you want to take an exposure in equities through the mutual fund route by investing in diversified equity schemes, you have to make a choice from among 170 actively-managed non-sectoral, non-thematic equity diversified funds and another 40 passively-managed equity index funds and exchange-traded funds (ETFs).

Choosing the right actively-managed equity fund is, undoubtedly, an onerous task. Investing in multiple funds is an option but on a limited corpus an investor may not be able to ensure adequate diversification. The same dilemma is faced when taking a diversified exposure in fixed income through debt schemes of mutual funds.

Investors can consider the mutual fund category of fund of funds (FoF) to get better and quicker diversification.

What is a FoF? A FoF scheme is one that does not invest in securities, equity or debt, of companies. As its name also suggests, it only invests in the units of other mutual fund schemes. An equity FoF will invest in only equity schemes; a debt FoF will touch only debt schemes; a equity-plus-debt FoF will have a mix of equity and debt schemes in its portfolio and a multi-asset FoF will invest in the units of one or more gold ETFs in its portfolio in addition to equity and debt schemes.

There are about 40 FoF schemes in existence today being offered by the same mutual funds that offer you equity, debt and other schemes. Of these, around 10 schemes are equity FoF schemes offered by about eight mutual fund houses; another 10 are debt FoF schemes; about eight are balanced equity-debt FoF schemes; one scheme is a multi-asset FoF; and the balance 11 schemes are gold-ETF FoF schemes.

Choosing a FoF: Choosing the right FoF is made relatively easy due to its small universe. Equity investors can go for equity FoFs, debt investors can choose debt FoFs and there is even a solitary FoF that invests in all the three asset classes of equities, debt and gold through exposure in units of equity, debt and gold ETF schemes.

An important element to keep in mind before deciding on a FoF of a mutual fund is whether its investments will be restricted to the schemes of the same mutual fund or whether it will invest in multiple mutual funds’ schemes. The ideal FoF is one that invests across the schemes of multiple mutual funds. Investors should avoid a single mutual fund-focused FoF scheme.

FoFs’ track record: A Financial Chronicle Research Bureau analysis of three- and five-year compound annual growth rate (CAGR) of return of equity FoFs as on January 15 indicates an outperformance of the CAGR of returns of benchmark equity index, S&P CNX Nifty’s Total Return Index. While Nifty TRI gave a three-year CAGR of 6.09 per cent return, six equity FoFs (in existence for over three years) gave an average three-year CAGR of 6.80 per cent return. The five-year Nifty TRI CAGR of return was 1.07 per cent, while five FoFs delivered an average CAGR or 3.07 per cent.

Performance-wise, therefore, equity FoFs have not disappointed. Go ahead and pick your one or more FoFs.

rajeshgajra@mydigitalfc.com

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