The Hindu Business Line : Investing in fund of funds

Suppose you have Rs 50,000 to invest. Will you prefer to invest it in just one fund? You may not because you risk losing your entire investment should the fund perform badly.

Investing your money in two or three funds is a simple way of reducing the risk of loss. This is because there is small chance of all three funds losing money during the same period. A fund of funds helps you reduce the risk of loss through such diversification.

Another advantage is manager selection. The performance of a mutual fund is dependent on its portfolio manager. If you select a good portfolio manager, you may be able to achieve higher returns.

But how will you select a good portfolio manager? As retail investors, we may be naive enough to select a fund that has done well in the last year, or perhaps, in the last three years.

Take a fund that invested in stocks of banking companies last year. That fund's one-year performance will be excellent. But what if the portfolio manager invested in banking stocks just by coincidence? Or what if the portfolio manager is unable to replicate his skills in other sectors?

In fund of funds, a portfolio manager will do the manager selection for you. The fund of funds manager understands the market better than you and I. So, we expect his manager selection to be more scientific than ours.

If he does his manager selection well, the fund of funds will not only help reduce risk of loss but also provide high returns. The fund of funds, typically, works well with hedge funds. Will the concept work in India?

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