Individual investors looking for a limited number of schemes in their equity portfolio could look at equity fund of funds (FoFs). Such funds are suitable for those who wish to diversify risk and gain access to a wide range of mutual fund-related investing opportunities.
However, after the amendments to the Finance Bill 2023, investors will have to keep in mind that they should opt for equity FoFs that invest at least 90% of its funds in exchange traded funds (ETFs) which, in turn, must invest at least 90% funds in equity shares of Indian companies traded on the stock exchanges. Post amendment, the fund which invests in ETFs in the above manner will continue to get benefits of lower tax on long term capital gains (LTCG).
After the amendments to the Finance Bill 2023, the fund which invests in other mutual funds will still be treated as debt funds for taxation. The gains will be taxed at the marginal slab rate of the investor irrespective of the holding period. This will apply even if all the funds into which the FoF has invested are equity-oriented funds.
“If the purpose of an individual investor is to allocate investment into various types of funds though a FoF, then it is better to invest in a fund that invests entirely in ETF which in turn have equity as underlying asset and not debt or commodities like gold,” says Sunil Gidwani, partner, Financial Services, Nangia Andersen LLP. Such funds will continue to be treated as equity-oriented funds where short term capital gains (holding period less than one year) will be taxed at 15% and LTCG (holding period over one year) above Rs 1 lakh will be taxed at 10%.
With a plethora of mutual fund schemes, even if an investor chooses a couple of schemes in a few of the categories, the portfolio will end up having multiple schemes. Such over-diversification of the portfolio tends to reduce the returns. Harish Menon, co-founder and head of investments and product research, House of Alpha, says FoF as a category offers a solution to DIY investors to outsource the scheme selection to fund managers.
“FoF category has seen a lot of innovation over the past few years and it now offers various options on the basis of risk appetite of investors, multiple asset classes, multi-geography portfolios, etc. By investing in one or two FoFs, one can effectively have a well-diversified portfolio based on their investment objectives,” he says.
What to consider before investing
Individuals must understand the investment objective and investment process of the FoF as well as the underlying schemes and only invest if it aligns with his investment objective and risk profile. They must also evaluate what FoF offers additionally to them, over and above direct investment into the underlying schemes.
Siddharth Srivastava, head, ETF Products, Mirae Asset Investment Managers (India), says investors have to bear the expenses of the relevant FoF scheme in addition to the expenses of the underlying schemes. “However, FoF on single ETF or multiple ETFs continues to be of low cost compared to active schemes as ETFs mostly are available at lower TER and regulatory TER limit of around 1% apply on such FoF schemes,” he says.
Asset-allocated FoFs may be a good idea for passive investors and would like automated asset allocated portfolios to be managed by fund managers in a MF format. Abhishek Dev, CEO and co-founder, Epsilon Money Mart,says cost is an important aspect to watch for in FOFs. “Given that there is two layers of costs, investors should keep an eye on the total costs,” he says.
While FoFs can be a useful tool for certain investors, one must weigh the potential advantages and disadvantages before investing. Manish Goel, founder and director, Research & Ranking, a Sebi registered equity investment advisory, says different mutual funds managed by FoF may have exposure to the same stocks and assets, resulting in duplication reducing the benefits of diversification. “Investors in an FoF have limited control over the underlying investments as the fund manager decides which funds to invest in and how much to allocate to each fund,” he says.
Like with any other equity investment, equity FoF works well only for long-term investment goals. So one must choose the portfolio composition that aligns with their risk appetite.
* It is better to invest in a Fund of Funds that invests entirely in ETF which in turn have equity as underlying assets and not debt or gold
* Asset-allocated FoFs may be a good idea for passive investors who would like automated asset allocated portfolios to be managed by fund managers in a MF format