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Investment Strategy: Fund of Funds (FOFs) - Explanation, Classifications, Benefits, and Risks

Diversifying investment across various mutual funds through Fund of Funds (FoFs) - Learn about their pros, cons, and whether it's worth investing in these investment strategies.

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Investment Strategy: Fund of Funds (FOFs), Description, Classes, Benefits, and Drawbacks
Investment Strategy: Fund of Funds (FOFs), Description, Classes, Benefits, and Drawbacks

Investment Strategy: Fund of Funds (FOFs) - Explanation, Classifications, Benefits, and Risks

International Fund of Funds (FOFs) are a unique type of mutual fund that allows investors to diversify their portfolios by investing in multiple international funds through a single investment. These funds offer a multi-layered approach to diversification, reducing overall portfolio risk and providing more consistent returns over time.

One of the key advantages of international FOFs is geographical diversification. By investing in multiple international mutual funds, FOFs spread investments across different economies such as the US, Europe, China, and emerging markets. This global spread reduces dependence on a single country's market performance and allows investors to capitalise on regions with better growth outlooks or currency advantages.

Another layer of diversification comes from FOFs' investment in various underlying funds that cover equity, debt, gold, and other instruments. Different fund managers add another layer of risk control by combining expert strategies, which helps offset losses if some markets or sectors underperform.

Professional fund selection and management are additional benefits of international FOFs. FOF managers conduct institutional-quality research and continuously optimise the underlying fund mix based on market conditions, which can improve risk-adjusted returns for investors who lack the resources or expertise to select international funds themselves.

Investors also gain exposure to profitable global corporations that may not be available locally and benefit from currency diversification, which can enhance returns if the investor’s home currency depreciates relative to foreign currencies.

International FOFs often allow small, periodic investments via SIPs (Systematic Investment Plans), making global diversification accessible even to smaller investors.

However, investors should be aware of the typically higher fees due to double layers of expense ratios and the possibility of overlapping holdings that could reduce true diversification. It is essential to ensure that the investments are well-aligned with the investor's risk profile and fit into their overall asset allocation strategy before investing in a FoF.

Investors should also ensure there isn't a lot of portfolio overlap with the other securities or assets in their portfolio. Gold Fund Of Funds (FOFs) are a popular choice for those looking to invest in paperless gold, while Asset Allocator or Multi-Asset Funds offer a diversified approach by investing in different asset classes such as equities, debt, and commodities like gold.

Fund of funds means a type of mutual fund that invests in other mutual funds. A few FOFs have a higher expense ratio than regular schemes because they are responsible for the costs of the underlying schemes in which the FoF has invested. If a FoF is classified as a debt fund, short-term capital gains (STCG) tax is applied if units are redeemed within three years of purchase. Long-term capital gains (LTCG) tax of 20% with indexation is applicable for investments sold after three years.

In conclusion, international FOFs are powerful tools for spreading investment risk internationally and potentially achieving higher, more stable returns than investing in single domestic funds alone. By offering multi-layered diversification, professional management, and easy access to global markets, international FOFs enable investors to benefit from international growth opportunities and currency diversification without the complexity of direct foreign investment.

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