Category : New to Investing October 7, 20255 minutes read
Fund of Funds and Exchange Traded Funds are some popular investment options in India. While Fund of Funds (FOFs) are mutual funds that invest in other funds, ETFs are traded on the stock exchanges. Fund of Funds provide an option to diversify portfolio in a single investment and ETFs offer direct exposure to indices or asset classes. Both investment options aim to simplify diversification but cater to different types of investors based on their goals, cost sensitivity, and familiarity with market trading.
Some of the key differences between fund of funds and ETFs is the need of a DEMAT account, availability of Systematic Investment Plans (SIPs), and flexibility through intraday trading.
A Fund of Funds (FOF) is a type of mutual fund that invests in other mutual funds, ETFs, or even hedge funds, rather than directly in stocks or bonds. This unique structure allows investors to gain exposure to a diversified portfolio managed by experts across multiple asset classes or geographies.
An Exchange-Traded Fund (ETF) is an investment fund that directly tracks an index, commodity, or asset class, and it is traded on the stock exchanges like a regular stock. ETFs combine the benefits of mutual funds (diversification) with the flexibility of stock trading (intraday transactions).
In this guide, we will explore the meaning of a fund of funds and its key features including diversification, accessibility, and provision of Systematic Investment Plans (SIPs). We will further discuss what an ETF is and how they work. We will also dwell into the features of ETFs including diversification and flexibility through intraday trading. Lastly, we will compare the features and benefits of FOFs vs ETFs, helping you identify which investment option may be suitable for you.
A Fund of Funds (FOF) in India is a type of mutual fund that pools money from investors to invest in other mutual funds or exchange-traded funds (ETFs), rather than directly investing in securities like stocks or bonds. This structure allows FOFs to offer a “fund of multiple funds” approach, creating a diversified portfolio with a single investment.
FOFs are professionally managed and can cater to specific investment themes, such as asset allocation, geographical exposure, or sector-based strategies. While they provide the benefit of diversification, they often come with higher costs due to a double layer of fees — one for the FOF itself and another for the underlying funds. In the FOF vs ETF debate, FOFs can often be seen as a more hands-off option for investors who prefer to leave portfolio management to experts, whereas ETFs require active involvement.
Features of a Fund of Funds
To further understand the meaning of a fund of funds, let’s explore some of its features including diversification, accessibility, and an option to invest through SIP.
Diversification
FOFs provide extensive diversification across multiple dimensions. Let’s understand some features of FoFs:
Asset classes: FOFs can invest in equities, debt, gold, or a mix of these, reducing the impact of underperformance in one asset class.
Geographies: They allow exposure to global markets, enabling Indian investors to benefit from international growth.
Sectors and themes: FOFs often focus on specific sectors (e.g., technology or healthcare) or investment themes, allowing investors to align their portfolios with emerging opportunities.
Market capitalisation: By investing in funds with small-cap, mid-cap, and large-cap strategies, FOFs ensure a well-rounded portfolio.
Compared to ETFs, FOFs may be better for achieving multi-dimensional diversification without the need for hands-on management.
Accessible
One of the key differences between FOFs and ETFs is their accessibility. Fund of Funds are accessible investments as investors can start with relatively small amounts, making them suitable for beginners. Unlike ETFs, which require a Demat account for trading, investments in FOFs can be done directly through mutual fund platforms or distributors. This ease of access removes the barriers often associated with investing in financial markets, making FOFs a simple yet effective investment tool.
Option for SIP
Another important factor to consider when comparing FOFs vs ETFs is the option for SIPs. Investors can invest in Fund of Funds through Systematic Investment Plans (SIPs), allowing investors to build their portfolios gradually through regular, smaller investments. This feature is particularly useful for those with limited disposable income or those seeking to average out market volatility over time. Unlike ETFs, which require lumpsum purchases and active trading, FOFs offer the convenience of disciplined investing via SIPs, making them a suitable option for long-term wealth creation.
Start investing in a Fund of Funds with SIPs today and build your portfolio gradually.
A Fund of Funds (FOF) in India is a mutual fund that invests in other mutual funds or ETFs, offering diversification across asset classes, geographies, and themes. It simplifies investment management by providing a single portfolio with exposure to equities, debt, gold, and international markets. Accessible to beginners, FOFs can be started with small amounts and don’t require a Demat account, unlike ETFs. They allow systematic investment plans (SIPs) for gradual portfolio building. While professionally managed, FOFs have higher costs due to double-layered fees. They suit investors seeking hands-off diversification without active involvement, unlike ETFs, which require direct management.
An Exchange-Traded Fund (ETF) in India is a type of investment fund that tracks an index, sector, commodity, or asset class, offering investors a cost-effective way to invest. Unlike mutual funds or Fund of Funds (FOFs), ETFs trade on the stock exchanges like shares, allowing real-time buying and selling at market prices. They are typically passively managed, aiming to replicate the performance of their benchmark rather than outperforming it.
Features of ETFs in India
To accurately compare ETFs vs FOFs it is important to explore the features of Exchange-Traded Funds in detail. Some of these features include diversification and flexibility through intraday trading.
Diversified
ETFs are well-diversified within the scope of their chosen focus:
Geographies: Some ETFs track global indices, allowing investors exposure to international markets like the US or Europe.
Market capitalisation: ETFs cater to small-cap, mid-cap, or large-cap investments, enabling targeted diversification within a specific segment.
Sectors: Sector-specific ETFs focus on industries like technology, healthcare, or financial services.
However, ETFs generally invest in a single asset class, such as equity or debt, meaning they are not diversified across asset classes. For example, an equity ETF will only track stocks, while a debt ETF focuses solely on fixed-income securities. This is an important difference to consider when comparing the asset allocation of FOFs vs ETFs as FOFs provide diversification across asset classes through a single investment.
Requirement of a DEMAT Account
To invest in ETFs in India, a DEMAT account is essential. This account is used to hold ETF units in electronic form and facilitates trading on the stock exchanges. Unlike FOFs, which can be purchased directly through mutual fund platforms without a DEMAT account, ETFs require this setup as they are traded directly on the stock-exchange, adding a layer of complexity for first-time investors.
Availability of Intra Day Trading
One of the most appealing features of ETFs is their ability to be traded throughout the day on the stock exchanges. Investors can buy or sell ETF units at prevailing market prices during trading hours, just like stocks. This provides greater flexibility and liquidity compared with FOFs, which can only be transacted at the end-of-day Net Asset Value (NAV). For investors seeking real-time control over their investments, this is a major advantage of ETFs over FOFs.
In essence, ETFs may be better suited for cost-sensitive, hands-on investors who want intraday trading flexibility and targeted diversification. Meanwhile, FOFs cater to those seeking professional management and broader asset-class diversification.
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An Exchange-Traded Fund (ETF) in India is a passively managed investment fund that tracks an index, sector, commodity, or asset class, offering cost-effective exposure. ETFs trade on stock exchanges like shares, enabling real-time buying and selling. They provide targeted diversification within specific sectors, geographies, or market capitalizations. To invest in ETFs, a DEMAT account is required, unlike Fund of Funds (FOFs). ETFs offer intra-day trading flexibility, allowing investors to buy and sell throughout the trading day, making them suitable for hands-on, cost-sensitive investors. In contrast, FOFs offer broader asset-class diversification and professional management.
Fund of Funds vs Exchange-Traded Funds: Key Differences
Fund of Funds (FOFs) and Exchange-Traded Funds (ETFs) are two distinct investment options, each with its own set of features suited to different investor needs. While FOFs provide diversification across multiple funds and can be a good option for investors seeking professional management, ETFs are passively managed, cost-effective, and traded like stocks, offering more flexibility for those who prefer real-time trading.
Parameters | Fund of Funds | Exchange Traded Funds |
Meaning | A mutual fund that invests in other funds instead of directly holding stocks, bonds, or commodities. | An investment fund that tracks an index, sector, or commodity and trades on the stock exchanges. |
Trading Price | Bought and sold at the Net Asset Value (NAV) calculated at the end of each trading day. | Traded on the stock exchanges at the market rate, which fluctuates during trading hours. |
Liquidity | Liquidity depends on mutual fund redemptions processed at the NAV price. | High liquidity, as ETFs can be traded in real-time during market hours, similar to stocks. |
Expense Ratio | Typically higher due to dual layers of management fees (FOF and underlying funds). | Lower, as ETFs are passively managed with minimal management fees. |
Asset Allocation | Multi-asset allocation, investing across equities, debt, commodities, or even global markets. | Generally focuses on a single asset class, such as equity, debt, or gold. |
Suitable for | Investors seeking professional management, broad diversification, and simplicity without a Demat account. | Cost-conscious, hands-on investors with a Demat account who prefer real-time trading flexibility. |
When choosing between Fund of Funds (FOFs) and Exchange-Traded Funds (ETFs), it’s important to consider factors like your investment horizon, risk appetite, and financial goals. While both options provide unique advantages, they cater to different types of investors. Here’s a breakdown of who should consider each scheme:
Investment Horizon
FOFs
Fund of funds may be a suitable investment option for long-term investors looking for broad diversification and a managed approach. Since FOFs often include equity, debt, and international funds, they may suit investors who plan to stay invested for 5+ years.
ETFs
A key difference to consider when comparing FOFs vs ETFs is the short-term viability of the investment. ETFs may be suitable for both short-term and long-term investors. ETFs offer flexibility, making them a preferred option for those who want to trade in the short term or maintain a long-term strategy with lower management fees.
Risk Appetite
FOFs
Diversification is an important aspect to consider while weighing the suitability of FOFs vs ETFs as FOFs provide diversified exposure, which may help reduce risk. However, since they may invest in various asset classes and sectors, they may still carry moderate to high risk, depending on the funds included. FOFs may be a suitable choice for those with a moderate risk appetite, especially if they prefer professional management to balance the risks.
ETFs
The risk in ETFs is generally aligned with the underlying asset class. For instance, equity ETFs can be volatile, while debt ETFs tend to be potentially more consistent. Investors with a higher risk appetite may prefer equity ETFs for potential growth, while those seeking lower risk can opt for bond or commodity ETFs.
Goals
FOFs
May be suitable for investors looking for diversified exposure across multiple asset classes with a goal of long-term growth. FOFs may be a suitable option for those who want professional management and a hands-off approach to their investments.
ETFs
Can be better suited for investors with specific market targets, such as those interested in tracking an index, sector, or commodity. If you have a clear investment goal (e.g., tracking the Nifty50 or investing in gold), ETFs can be a cost-effective, passive way to achieve it.
Understanding the difference between ETFs and FOFs will help you align your choice with your investment horizon, risk tolerance, and financial goals. Whether you choose FOFs for diversification or ETFs for flexibility, both options have distinct benefits for different investor profiles.
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When choosing between Fund of Funds (FOFs) and Exchange-Traded Funds (ETFs), consider your investment horizon, risk appetite, and financial goals. FOFs may be suited for long-term investors seeking diversification and professional management. ETFs cater to both short-term and long-term investors, offering flexibility and lower management fees. FOFs may suit moderate-risk investors looking for diversified exposure, while ETFs align with higher-risk investors, particularly those seeking equity investment. FOFs may be better for those seeking long-term growth with professional management, while ETFs are for specific goals, such as tracking indices or commodities, offering a cost-effective, passive approach.
- FOFs invest in other funds, offering professional management and broad diversification.
- ETFs track specific indices or asset classes and trade on the stock exchanges, offering flexibility and cost-effectiveness.
- FOFs are managed by professionals, but come with higher costs due to dual management fees.
- ETFs are typically passively managed, have lower fees, and offer flexibility for intraday trading.
- FOFs can be suitable for investors seeking diversification and professional management but have higher fees.
- ETFs are cost-effective, passive, and allow real-time trading, and may be a suitable option for those who prefer lower costs and flexibility.
- FOFs provide diversification across asset classes, geographies, sectors, and market caps, and are SIP-friendly.
- ETFs are diversified within their focus, typically tracking a single asset class, and require a DEMAT account for trading.
- FOFs can be better suited for long-term investors seeking professional management and diversified exposure.
- ETFs suit both short-term and long-term investors, especially those seeking lower costs and flexibility.
- FOFs have higher expense ratios due to layered fees (FOF and underlying funds), while ETFs have lower management fees.
- Both ETFs and FOFs are taxed based on the underlying assets.
- FOFs can be preferred by those wanting a professionally managed portfolio with broad diversification.
- ETFs cater to cost-sensitive, active investors seeking flexibility and targeted diversification in a specific asset class.