Capital Protection Funds come in when one wants reasonably high returns with fairly good security
Mutual funds invest investors' savings in equity, gold, real estate etc, which have different risk profiles, depending on market conditions.
But could there be a mutual fund, which in theory, outperform markets even when market conditions are bad? Could there be a mutual fund which could combine the advantages of various instruments and also diversify risk very effectively?
Illustration/Jishu Dev Malakar
Such a mutual fund does exist and it is called the Fund Of Funds (FoF).
So what exactly is an FoF?
Mutual funds that do not invest in financial or physical assets, but invest in other mutual fund schemes offered by different asset management companies are called Fund of Funds (FoF).
Such funds maintain a portfolio comprising of units of other mutual fund schemes, just like conventional mutual funds maintain a portfolio comprising of equity, debt or money market instruments or other non-financial assets.
So why do investors prefer FoF schemes?
Well, such schemes provide investors with an added advantage of diversifying into different mutual fund schemes with even a small amount of investment. Besides it also helps in diversification of risks. Investing in a fund of funds also saves the investor the bother of keeping track of all the schemes in the market and their net asset values (NAVs) as the fund manager does it for him.
What are their advantages?
Now, FoF schemes have certain advantages - they help build a solid and compact portfolio by reducing the number of funds, which an investor needs to manage, at the same time achieving excellent diversification of risk.
Technically speaking, a FoF could invest in the very best of mutual funds with excellent track records, that too from the best asset management companies.
What's more, an inbuilt portfolio rebalancing mechanism also ensures that an investor's asset allocation between equity and debt stays within the risk profile initially opted for.
Besides, FoF schemes appear to be more tax-friendly in terms of portfolio rebalancing - the investor does not incur any short or long term capital gains tax when hr or she re-jigs portfolio allocation
FoFs also allow for flexibility as well - an investor can invest in other sector specific schemes, and just as it is in the case of shares, he can enter and exit schemes depending upon which sector they want to be weighted in at a particular point of time.
Through an FoF, an investor can keep entering relatively better performing mutual funds and exiting mutual funds with relatively poor performance. An investor can also move his money into sector specific funds, which may be doing well at a particular time.
What are their disadvantages?
But, like every investment scheme, FoFs also have their disadvantages. For instance, the expenses of FoFs are quite high compared to ordinary mutual funds, because of compounding expenses of investments into different mutual fund schemes. After all, management fees have to be paid twice, since their cost structure will include the fees already charged by the mutual funds in which investments are made.
Another disadvantage is that since FoFs invest investing in several mutual funds which are themselves invested in a wide range of stocks, sometimes it is inevitable that it will invest in the same stock through different schemes!
However, in India, the Securities and Exchange Board of India (SEBI) has decreed that investments in schemes are under the same management be restricted to five per cent of the asset of the fund.
SEBI regulations have also put a ceiling on management expenses and this can probably take care of the final cost to investors.
In India, there are not too many FoF schemes, except by a few run by Franklin Templeton. But since there are enough number of mutual funds which ten to perform well, perhaps it is only a matter of time when more such schemes will hit the market.
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