ETF vs FOF

ETFs are lower risk as they replicate their underlying index with minimal tracking errors, while FoFs, being actively managed, have higher risk that may or may not lead to higher returns.
ETF vs FOF
3 min
21-June-2024

ETFs (Exchange-Traded Funds) and FOFs (Funds of Funds) are popular choices among investors when it comes to investing. Both offer diversification to your investment to strike a balance between risk and return. However, their approach to diversification is different from one another. In this ETF vs FOF comparison, we will learn about the differences and similarities between them. We will start learning about the difference between ETF and FOF by exploring what they are. Let us start knowing more.

What are ETFs?

ETFs are very similar to mutual funds. This financial instrument invests in baskets of diversified securities and most importantly you can trade them on the exchange. This makes exchange-traded funds offer you with more liquidity. As ETFs are passively managed, you can buy them at a more affordable price than mutual funds.

What are FOFs?

The full form of FOF is Fund of Funds. They are financial instruments that invest in multiple mutual fund schemes. This helps them create a diversified portfolio for their investors in a customised way per risk appetite and investment goals. FOFs are managed by the fund managers actively. This makes these financial instruments costlier than ETFs.

Differences Between ETF And FOF

There are 4 major differences between ETF and FOF. They are:

1. Trading

  • ETF
    ETFs or Exchange-traded funds are traded on exchanges. This offers investors with high liquidity.
  • FOF
    FOFs or Fund of Funds are less liquid than ETFs. If you sell FOF, it will be valued at the end of that trading day.

2. Management

  • ETF
    An ETF tracks an index. This means it is managed passively.
  • FOF
    FOF is managed by a fund manager actively. This means the choice of mutual fund schemes is altered by the fund manager to meet the goals and risk-taking potential of investors. If the return of any mutual fund falls below the benchmark index, the fund manager may replace it with a better-performing one.

3. Investment

  • ETF
    ETFs invest in baskets of diversified securities to provide you with portfolio diversification in accordance with your financial goals and risk profile.
  • FOF
    FOFs invest in different types of mutual funds, thereby offering you portfolio diversification across multiple mutual funds.

4. Cost

  • ETF
    The costs associated with ETFs are low. This is mainly because they are managed passively. As ETFs are not managed by the fund managers actively, their management cost is not added. This lowers the cost of ETFs.
  • FOF
    As these funds require active management of a portfolio of investments, the associated costs increase too.

ETF vs FOF - A Tabular Comparison

Here's a breakdown of the table content, along with some additional information that might help you choose between ETFs and FOFs:

Parameter

Exchange Traded Funds (ETFs)

Fund of Funds (FOFs)

Basic Structure

Basket of stocks, bonds, or other securities that track an underlying index.

Basket of diversified mutual funds. FOFs aim to cater to investors' risk tolerance and investment goals.

Price

Traded at market prices throughout the day, similar to stocks. ETFs with high trading volume tend to have market prices closer to their Net Asset Value (NAV).

Traded at their Net Asset Value (NAV) which is calculated at the end of each trading day.

Liquidity

High liquidity. ETFs can be bought and sold throughout the trading day like stocks.

Lower liquidity. FOFs cannot be traded actively throughout the day like ETFs.

Costs

Generally cheaper than mutual funds due to passive management and lower expense ratios (typically below 0.5%).

More expensive than ETFs due to active management. Investors may incur the expense ratio of the FOF itself, and the fees of the underlying mutual funds.

Taxes

Taxation on ETFs depends on the type of ETF (equity, gold, etc.).

FOFs are taxed like debt funds, regardless of the underlying mutual funds in the portfolio (equity or debt).

 

Additional considerations for ETFs vs FOFs

  • Management: ETFs are passively managed, meaning they aim to track an underlying index. FOFs are actively managed by fund managers who try to outperform the market by selecting underlying mutual funds.
  • Diversification: Both ETFs and FOFs can provide diversification, but FOFs can offer greater diversification due to the underlying layer of mutual funds.
  • Investment Goals: ETFs are a good option for investors who want low-cost, diversified exposure to a particular asset class or market. FOFs can be a good option for investors who want a professionally managed portfolio with diversification or those seeking specific asset allocation targets.

Which one should you choose between ETFs vs FOFs?

When you have to choose between ETF and FOF, your choice depends on three major factors:

  • Investment goals
  • Risk tolerance
  • Liquidity preference or diversification

Based on a mix of these factors, you will have to decide where you want to invest. You may also choose to invest in both ETFs and FOFs at the same time to further diversify your portfolio and consequently get the best of both worlds.

If you are a newbie in investing, you may visit the Bajaj Finserv Mutual Fund Platform, where 1000+ schemes are listed. You can compare mutual funds easily on the platform and therefore decide where to invest. You may use both the SIP calculator and the lumpsum calculator to calculate the return on your investment. This will help you choose between lumpsum investment and SIP investment.

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Frequently asked questions

What are the types of Fund of Funds (FOF)?
The different types of fund of funds include ETF fund of funds, multi-manager funds, international fund of funds, gold funds, and asset allocation funds.
What are the Different Types of ETF- Exchange Traded Funds?
The different types of ETF Exchange Traded Funds include Equity ETFs, Index Fund ETFs, Currency ETFs, Sector ETFs, Bond ETFs, Gold ETFs, Commodity ETFs, and Inverse ETFs.
Is it better to hold mutual funds or ETFs?
Your choice between mutual funds and ETFs depends upon your priorities. If your priority is to benefit from intraday trading’s flexibility, lower expense ratios, and tax efficiency, ETFs may be for you. If your concern is the impact of spreads and commissions, mutual funds may be for you.
Which is better ETF or index fund?
Most ETFs trade intraday shares through AMCs. It gives you more gains. However, the index funds majorly trade securities through AMCs. Index funds, essentially, give more security to investment. When you compare exchange-traded funds with index funds, the former are can be considered more risky than the latter.
Is it OK to hold ETF long term?
In the ETF prospectus, you will find that almost all leveraged ETFs mention a specific warning. It says that these financial instruments are not meant for long-term holding purposes. You may experience disastrous outcomes if you combine unfavourable return sequences, volatility of the market, and leverage.
What is the difference between MF and FOF?
A mutual fund scheme invests in stocks of companies, debt papers, and different securities on behalf of their investors. However, in the case of fund of funds, the fund managers invest in one or multiple mutual fund schemes. This depends on the underlying investment strategy.
How does FOF work?
FOF is also called a multi-manager investment. These are mutual fund schemes that invest in the units of other schemes of the same mutual fund or other mutual funds. I The portfolio of FOF includes a wide range of underlying portfolios of funds.
How are FoF taxed in India?
If your investment in a FOF account is squared off within three years, a short-term capital gains tax will be applicable. The profits you generate will be added to your yearly income and then taxed according to the applicable tax slab.
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Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.