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FUND OF FUND - A COMPLICATED WRAPPER

Posted on 28 May 2021

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Fund of Fund – A Complicated Wrapper

Nishant Batra – Research Head

I could have named this article as A to Z about Fund of Funds but decided otherwise and went for “a complicated wrapper”. It will be short article as compared to the previous ones, but it will cover everything about Fund of Funds (FOF), A to Z about fund of funds ??

Let’s start with the very basic, what is Fund of Fund?

This category of Mutual Fund schemes invests the money in schemes of mutual funds and not directly in securities like shares, bonds, gold, etc.

There are primarily four kind of fund of funds

  1. Wrapper Around ETF
    That just provide a wrapper on ETF, it can be gold ETF or an ETF replicating a benchmark like junior bees, Bharat Bond, bharat22, Nasdaq 100. In these types of FOF, AMC launches a FOF just to tap on to the investors who doesn’t have demat account and who want to enter into systematic transactions like SIP, STP and SWP as these features are not available in ETF.
  2. Multi Manager within same asset class
    Which provides multi manager mandate. Here the fund manager has the mandate to invest in different strategies, usually within the same asset class. Let’s take an example of ICICI Prudential India Equity FOF, this FOF is allocating mainly into equity strategies, some liquidity to meet redemptions.Axis All Seasons Debt Fund of Funds is another example, instead of equity it is allocating in fixed income strategies.Mirae Asset Equity Allocator Fund of Fund also qualifies in this category.
  3. Multi Asset classes
    Another set of Fund of Fund invests in different asset classes and some of them manages these asset classes dynamically, yes just like balanced advantage fund. Franklin India Dynamic Asset Allocation Fund of Fund manages the mandate dynamically whereas Franklin has different life stages FOF as well which follow different mandates.
  4. Feeder Funds
    A different genre of FOF invests in feeder funds, this could be due to geographical and currency diversification or lack of investment avenues on a particular avenue in India, for example, Edelweiss has a tie up with JP Morgan, DSP has a tie up with BlackRock, Axis has arrangements with Schroderbut global asset management companies operating in India like Franklin, HSBC or any other global asset manager, prefers to choose the underlying scheme of their parent company only. Examples of these funds can be, HSBC Global Equity Climate ChangeFund of Fund and Axis global equity alpha fund of fund.

DSP World Energy Fund and DSP World Gold Fund also fall in this category which invest in avenues for which sufficient investment alternatives are not available in India.

There are some advantages of investing in a Fund of Fund:

  1. Underlying funds, based on expertise of underlying fund managers and market dynamics, are chosen by fund management team of an Asset Management Company. I feel this is true only for those FOF who have invested in schemes of other asset management companies as well.
  2. Investors are guaranteed equitable NAV. All investors are given same NAV for a particular day, whatever is the amount for investment and whether it’s a buy or a sell transaction. Here I am not using fair NAV but using equitable NAV. We will come to this later in the article.
  3. By investing in Fund of Funds, we can take international exposure which provides diversification to the portfolio. These FOF saves retail as well as HNIs to take the complicated route of opening a foreign bank account, sending money through Liberalized Remittance Scheme, paying retail spread of currency conversion, filing complicated tax returns and estate duty in case of death of unitholder. Please note, these funds also pay spread but being institutional investors, the spread is very miniscule.
  4. These FOFs also offer thematic opportunities not available in India. For example, exposure in World Energy Companies, Gold mining companies, etc.

There are two sides of a coin, here are the disadvantages:

  1. Additional cost for wrapper. The total expense ratio for FOF are subject to following limits:

Did you know?

All non-FOF schemes of anAsset Management Company “cumulatively” cannot invest in schemes of the same AMC or other AMCs more than 5% of the total assets of the Mutual Fund (it is not 5% at individual scheme level, it is at AMC level)

  1. Different Valuation methodologies adopted by different AMCs to calculate the day end NAV of Fund of Fund. We will discuss this along with point 2 of advantages later in the article.
  1. In case you have invested in a FOF which invests either fully or a part of their AUM in any category of debt schemes, please remember, in case of a credit event, the segregated part of the portfolio will only be reserved for the FOF and not for the ultimate beneficiaries i.e. unit holders. Recoveries in segregated portfolio will be shared to the unitholders of FOF on the day of recovery and not on the day of segregation. You can refer to the example of Franklin India Life Stage Fund of Fund – 50’s Plus Plan, in this fund, the segregated portfolio of Vodafone idea is there, and the recovery proceeds will be given to those investors of FOF which are holding units on the day of recovery.