What Is a Fund of Funds and How Is It Taxed?

Short answer: A fund of funds invests in other mutual funds rather than directly in stocks or bonds, offering ready-made diversification and professional selection of underlying funds, at the cost of an extra layer of fees.

How It Works

A fund of funds pools your money and invests it in a basket of other mutual fund schemes instead of buying securities directly. The manager chooses and rebalances the underlying funds, so you get exposure to several strategies or asset classes through a single investment.

Common Uses

Funds of funds are used to package multi-asset portfolios, to give access to overseas funds, or to bundle gold and other exposures conveniently. For an investor who wants a single, hands-off, diversified product and is happy to delegate fund selection, they offer simplicity.

The Cost Consideration

The main drawback is fees on fees — you bear the fund of funds' own expense ratio on top of the costs of the underlying funds. This extra layer can eat into returns, so it is worth checking the total cost and asking whether you could assemble similar exposure more cheaply yourself.

The Tax Treatment

A fund of funds is taxed based on its own classification under the tax rules, which may differ from how you would be taxed holding the underlying funds directly. The holding period for long-term treatment and the applicable rate depend on that classification, so confirm how a specific fund of funds is taxed before investing.

Who Should Consider One

Funds of funds suit investors who value convenience and one-decision diversification over squeezing out the last bit of cost, or who want access to exposures that are otherwise hard to reach. Cost-conscious do-it-yourself investors can often replicate the exposure directly and avoid the extra fee layer.

Sources: SEBI Investor Education

This explainer was written by The Dispatch desk to answer a question readers commonly ask. It is general information, not personalised financial advice.