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Does a fund of funds investing in multiple ETFs carry low risks?

With equity markets having recovered in a broad-based manner from the COVID-19 lows of March 2020, fund houses do not just want to mimic basic market indices. They want to outperform.

October 13, 2021 / 10:01 AM IST

Most of the fund of funds (FoFs) that invest in domestic or overseas equities do so via just one exchange-traded fund (ETF) or index scheme. But with an increasing number of ETFs in India and overseas, FoFs are getting adventurous and are investing in multiple ETFs.

To be sure, FoFs have been around for almost two decades. So, what’s different about their offerings now?

Overcoming the taxation limitation

An FoF is typically taxed as a debt scheme, even if it invests in equity funds. This is also why all FoFs that invest in international funds or stocks are taxed as debt schemes.

Budget 2019 made a small modification. It said that all FoFs that invest in Indian ETFs will be taxed as equity funds. Profits earned from selling units of an equity fund held for more than one year are treated as long-term capital gains and taxed at 10 percent, if the gains exceed Rs 1 lakh. In the case of debt funds, the gains earned on units sold after three years are treated as long term capital gains, and taxed at 20 percent after indexation. The relaxation in taxation was to nudge more investors to invest in FoFs that invest in government-led disinvestment ETFs.

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Multiple underlying funds give returns kicker

How are Mirae Asset Equity Allocator Fund of Funds (MAEF) and ICICI Prudential Passive Strategy Fund of Funds (IPSF) different from traditional FoFs? MAEF and IPSF invest in multiple ETFs. Other FoFs stick to single ETFs. But why go through multiple ETFs?

With equity markets having recovered in a broad-based manner from the COVID-19 lows of March 2020, fund houses do not just want to mimic basic market indices. They want to outperform. MAEF positions itself as a large-cap fund and doesn’t limit itself to a large-cap market index such as Nifty 50 or S&P BSE Sensex. Instead, it invests in Nifty 50, Nifty Midcap ETF and Nifty Next 50 ETFs.

ICICI Prudential Passive Strategy Fund of Funds (IPSF) invests in a mix of ETFs focused on domestic equities. It has invested in the ETFs tracking S&P BSE 500, Nifty, private banks and Healthcare segments. IPSF positions itself in the flexi-cap category. In fact, this is ICICI Prudential MF’s second passive fund in this category. Its other scheme, ICICI Prudential S&P BSE 500 (IP500) invests in the S&P 500 index.

Swarup Mohanty, Chief Executive Officer, Mirae Asset Investment Managers (India) says, “Investors keen to allocate money to ETFs tracking large and mid-cap indices should consider investing in MAEF. Investing in a bouquet of index ETFs designed using a rule-based model should work, as outperforming the benchmark indices becomes a tough task.” MAEF completed a year and has assets of Rs 178 crore.

Are passive FoFs investing in multiple ETFs worthwhile?

Apart from the taxation benefit, these FoFs are managed a bit more actively. IPSF can choose among various domestic equity ETFs – broad-based indices or those focused on specific sectors or themes. The fund has given 59.15 percent and 17.11 percent returns over the past one and three-year periods, respectively. The assets under management of the scheme stand at Rs 88 crore.

Still, diversifying across multiple ETFs is no guarantee for outperformance. IPSF gave 59 percent return over the past one year; IP500 delivered 60 percent return. ICICI Prudential Focused equity Fund gave 63.58 percent return over the past one year.

MAEF has done better. In the past one year, it gave 57 percent return. Mirae Asset Large Cap Fund gave 52 percent return. Mirae’s own Nifty 50 focused fund gave 53 percent return.

Remember, FoFs that invest across multiple ETFs also change their underlying portfolios. Though these funds invest in passive schemes (ETFs), some of them are managed actively. MAEF has kept the allocations stable. But IPSF is dynamic. It had invest 12 percent of its assets in Bharat 22 ETF in May 2020; this gradually decreased to 4.28 percent in August 2021. It has also juggled its exposures between a S&P BSE 500 index ETF and a Nifty ETF over the past two years, as per ACE MF data.

“Investors keen on ETFs, but not having the understanding or time to select the right combination of ETFs should look at ICICI Prudential Passive Strategy Fund (FoF),” Chintan Haria, Head-Product Development & Strategy at ICICI Prudential AMC.

“For investors keen to avoid fund manager risk, a scheme such as Mirae Asset Equity Allocator is a good vehicle to invest in ETFs, if the scheme sticks to the rule-based strategy of allocating money,” says Harshvardhan Roongta, Principal Financial Planner, Roongta Securities.

Moneycontrol’s take

SEBI’s re-categorisation of mutual funds in 2017 has put a stop to fund houses launching more than one scheme per category. But as Moneycontrol has previously pointed out, one of the few windows that SEBI has given fund houses is allowing multiple ETFs. And they appear to be taking the benefit of this exception. That is one reason why have seen a proliferation of ETFs in existing fund houses.

An FoF that invests across multiple ETFs brings an element of active management. Check the scheme’s track record and legacy in the segment.
Nikhil Walavalkar
first published: Oct 13, 2021 10:01 am

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