Fund of Funds & International Funds
Definition
A Fund of Funds (FoF) is a mutual fund scheme that invests in units of other mutual fund schemes — either domestic or international — rather than directly investing in stocks, bonds, or other securities. The underlying funds may be from the same AMC or different AMCs. International Funds (also called overseas funds or global funds) are schemes that invest in equity or debt securities of companies listed in foreign markets (US, Europe, Emerging Markets, etc.). International investing can happen through direct international funds, feeder funds (a domestic FoF that feeds into a single international fund), or fund of funds that invest in multiple international schemes. Key regulatory constraint: SEBI has imposed a combined industry-wide limit of USD 7 billion for overseas investments by mutual funds, which has caused several international funds to temporarily stop accepting new investments when the limit was breached.
In Simple Words
Fund of Funds and International Funds are two concepts that often overlap but are not the same thing. It is important to separate them clearly. A Fund of Funds is a structural concept — the fund does not buy stocks or bonds directly but instead buys units of other mutual fund schemes. Think of it as a mutual fund that invests in mutual funds. This creates a double-layering of expenses — the FoF charges its own expense ratio, and each underlying fund also charges an expense ratio. So if the FoF charges 0.5% and the underlying funds charge an average of 1.0%, the effective total cost is 1.5%. This is the biggest criticism of FoFs. However, FoFs offer a significant advantage: asset allocation and diversification across multiple fund managers and styles in a single investment. International Funds, on the other hand, are about geography — investing outside India. This matters because India represents only about 3-4% of global market capitalization. By investing only in India, clients are ignoring 96% of the world's investment opportunities — including companies like Apple, Google, Microsoft, Tesla, Samsung, and TSMC that have no Indian equivalent. Industry experience shows that the biggest missed opportunity for Indian investors has been ignoring international diversification. When Indian markets fell 35% during COVID, US markets recovered in months. Having 10-15% in international funds would have cushioned the fall significantly. The practical challenge is the SEBI limit of $7 billion on industry-wide overseas investments, which was breached in early 2022, forcing most international fund NFOs and fresh investments to halt temporarily. This created a situation where existing investors could continue SIPs but new investors could not enter. An important nuance often overlooked about FoFs is that they are excellent for accessing asset classes that retail investors cannot easily access directly — like gold (Gold FoFs invest in Gold ETFs for investors without demat accounts), international markets (Feeder FoFs invest in global funds), and multi-asset strategies. Currency risk is the other critical factor in international investing — if the rupee depreciates against the dollar, international fund returns get a boost; if the rupee appreciates, returns get reduced. Historically, the rupee has depreciated 3-4% annually against the dollar, providing a tailwind for international investments.
Real-Life Scenario
Consider the case of Suresh, a 45-year-old IT architect in Pune, earning ₹3.5 lakh per month with his entire ₹1.2 crore portfolio in Indian equity funds. His son Arjun was studying at Georgia Tech in the US, and Suresh was experiencing firsthand the impact of rupee depreciation — his son's annual expenses of $40,000 were costing more every year in rupee terms. In 2019, $40,000 cost ₹28 lakh (at ₹70/$). By 2023, the same $40,000 cost ₹33.2 lakh (at ₹83/$). That is ₹5.2 lakh more per year, purely due to currency depreciation. His financial advisor recommended that Suresh invest 15% of his portfolio — ₹18 lakh — in international funds. They chose a Nasdaq 100 FoF (through Motilal Oswal) and a US-focused Feeder Fund (through Franklin Templeton). The Nasdaq 100 FoF invests in the Motilal Oswal Nasdaq 100 ETF, which tracks the Nasdaq 100 index (Apple, Microsoft, Google, Amazon, etc.). The FoF charges 0.10% expense ratio on top of the ETF's 0.50%, making the total cost 0.60%. For his ₹18 lakh, the Nasdaq 100 component returned about 22% CAGR in INR terms over 3 years — partly because the Nasdaq index performed well and partly because the rupee depreciated from ₹74 to ₹83 against the dollar, adding roughly 4% annual return in INR terms. The international allocation served two purposes: it provided genuine geographic diversification (US tech performed differently from Indian markets), and it acted as a natural hedge against his dollar-denominated liability (Arjun's education). As the advisor explained, "the international fund goes up when the rupee falls, which is exactly when your son's fees go up in rupees" — Suresh immediately understood the value. Today, 20% of his portfolio is in international funds, and he calls it his "dollar insurance."
Key Points to Remember
Formula
Effective Expense Ratio of a Fund of Funds: Total Cost = FoF Expense Ratio + Weighted Average Expense Ratio of Underlying Funds Example: FoF expense ratio: 0.50% Underlying Fund A (40% allocation): 1.20% expense ratio Underlying Fund B (35% allocation): 0.80% expense ratio Underlying Fund C (25% allocation): 1.50% expense ratio Weighted underlying expense = (0.40 × 1.20) + (0.35 × 0.80) + (0.25 × 1.50) = 0.48 + 0.28 + 0.375 = 1.135% Total effective expense ratio = 0.50 + 1.135 = 1.635% Currency Impact on International Fund Returns: Return in INR = ((1 + Return in Foreign Currency) × (1 + Currency Depreciation)) - 1 If US fund returns 12% in USD and INR depreciates 4% vs USD: Return in INR = ((1.12) × (1.04)) - 1 = 1.1648 - 1 = 16.48%
Numerical Example
Fund of Funds — Double Expense Impact: Scenario: ₹10 lakh invested for 10 years at 12% gross return Direct Fund (expense ratio 1.00%): Net return: 12% - 1.00% = 11.00% ₹10,00,000 × (1.11)^10 = ₹28,39,000 FoF route (total expense 1.60%): Net return: 12% - 1.60% = 10.40% ₹10,00,000 × (1.104)^10 = ₹26,90,000 Cost of double expense over 10 years: ₹28,39,000 - ₹26,90,000 = ₹1,49,000 Currency Risk Example: Ankita invests ₹5,00,000 in a US Equity Feeder Fund when USD/INR = ₹75 Dollar equivalent invested: $6,667 After 2 years: US fund value in USD: $8,000 (20% USD return) Scenario A: INR depreciates to ₹83 Value in INR: $8,000 × ₹83 = ₹6,64,000 INR return: (6,64,000 - 5,00,000) / 5,00,000 = 32.8% (Currency depreciation added 12.8% to the 20% USD return) Scenario B: INR appreciates to ₹72 Value in INR: $8,000 × ₹72 = ₹5,76,000 INR return: (5,76,000 - 5,00,000) / 5,00,000 = 15.2% (Currency appreciation reduced the 20% USD return to 15.2%)
Frequently Asked Questions
Test Your Knowledge
4 questions to check your understanding
What is the primary disadvantage of investing through a Fund of Funds (FoF)?
Summary Notes
Fund of Funds invest in other mutual fund schemes — convenient for accessing asset classes like gold or international markets, but come with a double expense ratio that erodes returns
International diversification is essential — India represents only 3-4% of global market cap, and 10-15% international allocation provides genuine geographic diversification
Currency risk is a double-edged sword — rupee depreciation (historically 3-4% per year vs USD) boosts INR returns, but rupee appreciation reduces them
The SEBI $7 billion overseas investment limit is a practical constraint that has disrupted international fund availability — always check if a scheme is accepting fresh investments
International fund taxation has changed: FoFs investing in international schemes bought after April 2023 are taxed at slab rate regardless of holding period; direct international equity funds qualify for 12.5% LTCG after 24 months — factor this into recommendations