Feb 19, 2013, 05.25 PM IST | Source: CNBC-TV18

Fund of funds: All you wanted to know

Hemant Rustagi, Wiseinvest Advisors discusses the pros and cons of investing in fund of funds. In an interview to CNBC-TV18 he said, there are three types of fund of funds that are available to investors in India.

Hemant Rustagi, Wiseinvest Advisors discusses the pros and cons of investing in fund of funds.

In an interview to CNBC-TV18 he said, there are three types of fund of funds that are available to investors in India.

First, there are fund of funds that invest into schemes of the same mutual funds. Second, there are fund of funds that invest into schemes of other mutual funds. Third, there are fund of funds that allow investors to invest in international funds thereby allowing them to diversify their portfolio internationally. There are lot these fund of funds can offer to the investors, he added.

Below is the verbatim transcript of his interview on CNBC-TV18

Q: In theory, a fund of funds has very obvious benefits; it takes the wisdom of several fund managers. Is that really the case in terms of actual performance? Why haven't they managed to pick up in India as a concept itself?

A: One of the major advantages of investing in mutual fund is that they offer a variety of funds. However considering the fact there are hundreds of funds to choose from, it can be quite a daunting task for investors to make the right selection. In that context if you really see fund of funds can be a pretty good option as it not only allows investors to invest in funds that invest in different asset classes, following different investment philosophies, but also they can do so by investing much lower amount than if they were to invest in these funds separately.

The funds that invest in more than one asset class have a pre-decided asset allocation, which means that they maintain it at all times. The major advantage for investor here is that they do not have to worry about rebalancing their asset allocation every now and then.

Check out the performance of Fund of Funds schemes

Currently, there are three types of fund of funds that are available to investors in India. First, there are fund of funds that invest into schemes of the same mutual fund. In this category there are gold saving funds that allow investors to invest in gold ETF without having to open a demat account, which are the most prominent ones. The advantage of investing in this fund of funds is that investors can invest through Systematic Investment Plan (SIP) which they cannot do in gold ETF.

Second, there are fund of funds that invest into schemes of other mutual funds. Presently there are only one or two mutual funds that offer this kind of fund.

Third, there are fund of funds that allow investors to invest in international funds thereby allowing them to diversify their portfolio internationally. In this category, there are country specific funds, region specific funds and also thematic funds that invest in different commodities like you have gold funds, natural resources fund and also the fund that invests in emerging market. So there is lot that this fund of funds can offer to the investor.

Unfortunately, despite the fact that fund of funds are quite popular globally, they have failed to make an impact in India and I believe there are few reasons for that. First, most of the funds in India, especially the domestic ones that invest in different asset classes, invest in the schemes of their own mutual funds, which mean that investors have to rely on the expertise of the fund managers of the same fund house and that restricts the options for them.

Second, any investor in a fund of funds has to bear expenses of the fund of funds and also the underlying fund. The common perception is that these are more expensive funds. However, the fact remains here that Securities and Exchange Board of India (Sebi) has capped expenses at 2.5 percent and there are a number of funds that are charging much less than this cap.

Third, the major drawback for fund of funds is that their tax treatment. Even if a fund has more than 65 percent exposure to equity, which is the basis of considering an equity fund for tax purposes, this fund of funds is still considered as a debt fund. This means that the fund has to pay dividend distribution tax, investors have to pay long-term capital gain at 10 percent and then short-term capital at a nominal tax rate.

Q: What have been the annual returns or three year returns of these funds vis-à-vis the best in class equity and best in class debt and therefore are you telling our investors to invest or not invest in fund of funds?

A: The only major problem is the tax treatment. I think the time has come to realize that they have to be treated on par with other balanced funds. If that happens, I see a major change and I see a lot of investors then preferring to invest in them because they are a very simple way to invest in different funds through a single investment.

Caller Q: I earn around Rs 7,000 per month. How should I allocate my funds? How much should I put in each mutual fund? Also can you suggest good fund of funds investment options?

A: I think it is good to see someone who is at the beginning of his career and looking at starting the process of investment and that too considering mutual funds to invest in. There are few things that he really needs to focus on before he starts investing.

One, he needs to do a proper budgeting and that will decide as to how much money he can invest every month, because he definitely needs to avoid a situation where he starts investing any amount and then stop the process midway through.

Second, he needs to be very, very clear in terms of his time horizon, because that decides as to how much money has to go into equity or debt. So, he really needs to focus on these two points.

My advice to him would be that if his time horizon is one year or thereabouts, considering that his total income will not attract any income tax he should be looking at bank deposit or recurring deposit rather than looking for mutual funds.

However, if he can invest for longer period, maybe five years or more than depending on the kind of risk he wants to take, he can either consider debt-oriented hybrid funds like monthly income plans. There one or two funds like HDFC MIP Long-Term, or Reliance MIP or he can look at equity oriented balance fund where he can look at HDFC Prudence.

These are two-three factors that he needs to look at and then decide where he should be investing his money.

Q UTI was the only mutual fund for the period of:

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