Executive Overview

Funds of Funds (FoFs) occupy a unique and often misunderstood position in the Indian mutual fund ecosystem. Unlike traditional mutual fund schemes that invest directly in equities or bonds, FoFs deploy capital into other mutual fund schemes, making portfolio construction—not security selection—their primary value proposition.

In an environment where retail investors dominate flows but often struggle with diversification, timing, and rebalancing discipline, FoFs aim to solve a behavioural and structural problem rather than a market inefficiency. This article explains FoFs end to end, integrates recent performance evidence, highlights India‑specific taxation and regulatory nuances, and identifies the top-performing FoFs over the last three years, all while setting realistic expectations.

Why Funds of Funds Exist in the Indian Market

India’s mutual fund participation has expanded rapidly, but portfolio quality has not always kept pace. Common patterns include:

• Over‑concentration in one equity category or theme

• Performance chasing based on recent returns

• Infrequent or emotional rebalancing

• Limited understanding of asset allocation

FoFs emerged as a structural response to these issues. Their core objective is not to beat the market every year, but to deliver:

• Diversification across strategies, market caps, and fund houses

• Allocation discipline across market cycles

• Reduced behavioural errors for long‑term investors

FoFs therefore function as portfolio design products, not tactical trading tools.

What Exactly Is a Fund of Funds?

A Fund of Funds is a mutual fund scheme that invests predominantly in other mutual fund schemes rather than directly holding securities. The underlying funds may include equity, debt, hybrid, ETF, or international funds.

For the investor, this creates a portfolio of portfolios, where returns are driven by:

• Performance of underlying funds

• Allocation weights between those funds

• Rebalancing decisions over time

How FoFs Work: Structure and Mechanics

Asset Allocation Framework

The FoF fund manager’s primary responsibility is asset allocation. This includes deciding:

• How much capital goes into equity, debt, or other asset classes

• How exposure is distributed across fund styles or geographies

• When and how rebalancing is carried out

Unlike retail investors, FoF managers rebalance systematically, enforcing discipline during market extremes.

Underlying Fund Selection

Underlying funds are chosen using quantitative and qualitative filters such as:

• Long‑term consistency of returns

• Risk‑adjusted performance

• Stability of investment process

• Expense efficiency and portfolio overlap

Importantly, changes to underlying funds do not trigger tax events for investors.

Types of Funds of Funds Available in India

• Equity FoFs: Invest in multiple domestic equity funds across market capitalisations or strategies.

• Debt FoFs: Allocate to various debt and money‑market funds for income or stability.

• Hybrid / Asset Allocation FoFs: Combine equity, debt, and sometimes gold or arbitrage strategies.

• International FoFs: Provide overseas exposure through feeder structures or global ETFs.

• Passive / ETF FoFs: Invest in index ETFs or factor‑based ETFs with rules‑based allocation.

SEBI Regulation and Classification Nuances

SEBI regulates FoFs under the mutual fund framework with enhanced disclosure requirements. Key points investors often miss:

• FoFs are classified separately from pure equity or debt funds

• Risk‑o‑meters reflect aggregate underlying risk

• Full look‑through portfolio disclosure is mandatory

Crucially, FoFs do not automatically receive equity tax treatment, even if they invest largely in equity funds.

Taxation of Funds of Funds: The Critical Reality

Taxation is one of the most decisive factors in FoF outcomes.

• FoFs are taxed based on the nature of the FoF itself, not the underlying funds

• Most FoFs are treated as non‑equity funds for tax purposes

• International FoFs are always non‑equity

This means capital gains are typically taxed at slab rates in the short term and with indexation benefits in the long term, which can materially reduce post‑tax returns compared to direct equity funds.

Cost Structure: Understanding the Double‑Expense Effect

FoFs carry two layers of cost:

1. Expense ratios of underlying funds

2. Management fee at the FoF level

While SEBI caps FoF expenses, the cumulative cost is higher than direct investing. Over long periods, even a modest additional cost can compound meaningfully, making cost awareness essential.

Performance Drivers and How to Evaluate FoFs

FoF performance depends on:

• Quality of underlying fund selection

• Asset allocation effectiveness

• Rebalancing discipline

• Cost efficiency

Evaluation should focus on:

• Rolling returns rather than point‑to‑point performance

• Drawdown control during market corrections

• Volatility and downside capture

• Consistency across market cycles

Top 5 Fund of Funds in India by 3‑Year Performance

Based on available three‑year return data and peer comparisons, the following FoFs have emerged as leading performers:

1. ICICI Prudential BHARAT 22 FOF

2. ICICI Prudential India Equity FOF

3. Mirae Asset NYSE FANG+ ETF FoF

4. Nippon India Nifty Next 50 Junior BeES FoF

5. ICICI Prudential Nifty Alpha Low‑Volatility 30 ETF FoF

These funds benefited from either smart‑beta exposure, disciplined passive strategies, or concentrated thematic positioning. Investors should note that strong historical performance may also imply higher volatility and different tax outcomes.

When FoFs Tend to Underperform

FoFs may lag during:

• Narrow, momentum‑driven bull markets

• Phases where single‑category equity funds dominate

• Periods when passive indices outperform diversified allocation strategies

Understanding this prevents unrealistic expectations.

FoF vs Direct Mutual Fund Investing

Who Should Consider Funds of Funds?

FoFs are well suited for:

• First‑time or time‑constrained investors

• Goal‑based portfolios requiring allocation discipline

• Investors prioritising risk management over return maximisation

They are less suitable for highly cost‑sensitive or hands‑on investors.

Practical FoF Selection Checklist

Before investing, examine:

• Overlap among underlying funds

• Aggregate expense ratio

• Rebalancing frequency and philosophy

• AMC track record in allocation products

• Transparency of disclosures

Key Takeaways

• FoFs are portfolio construction tools, not alpha products

• They trade cost efficiency for diversification and discipline

• Tax treatment can significantly impact outcomes

• Best used for long‑term, goal‑oriented investing

Final Perspective

Funds of Funds play a meaningful role in India’s evolving mutual fund landscape by addressing behavioural and structural gaps rather than attempting to outsmart markets. For investors who value process over prediction, FoFs can serve as durable building blocks within a well‑designed investment strategy.