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For DIY investors, fund of funds solve the equity allocation problem

Do-it-yourself investors can use these schemes for the core portion of their equity portfolio with a five-year timeframe

April 27, 2021 / 09:46 AM IST

Though the fans of passive investing are growing in number, the case for active investing is still strong in Indian equities. That makes many investors look for better-performing schemes. Even if you get your asset allocation right, choosing the right schemes is a tough task, as it involves tracking hundreds of funds. If you are a do-it-yourself investor facing this problem, then you have the option of buying an equity fund of fund (FOF). But you should understand how they work and have realistic expectations from them.

Types of equity fund of funds

These are schemes that invest in other equity funds. Some also invest in the equity schemes of other mutual fund houses. For example Quantum Equity FoF (QEF) and ICICI Pru India Equity FoF (IPE) invest in the equity schemes of other fund houses. Aditya Birla Sun Life Financial Planning FoF Aggressive Plan (ABFPF) can invest up to 85 percent of its portfolio in equity schemes – its own and those of other houses as well.

The second type of FoF invests in its own equity funds. For example, IDFC Asset Allocation Fund- Aggressive Plan (IAAF) invests up to 80 percent of its assets in equity schemes. Nippon India Passive Flexicap FoF deploys sums in passively managed schemes of its house.

Then, the likes of Mirae Asset Equity Allocator FOF (MAEF) and ICICI Pru Passive Strategy FOF (IPPSF) invest in a mix of exchange traded funds (ETF) managed by their own fund houses.

Chirag Mehta, Senior Fund Manager-Alternative Investments, Quantum Asset Management Company says, “We choose actively managed diversified equity schemes based on long-term consistent outperformance, ascertained using qualitative and quantitative factors. Non large-cap equity exposure is restricted to one-third of the scheme’s portfolio.”

How have these schemes performed?

Given their highly diversified portfolios, FoFs may deliver reasonable, but not top-notch returns. For example, QEF has given 12.25 percent and 11.74 percent over five and ten year periods, respectively, as per data from Value Research. The flexicap funds category delivered 12.96 percent and 11.63 percent, respectively over the same period. The scheme’s current portfolio has seven diversified equity funds of other houses. Most of the funds in this category have limited performance history.

Those who cannot pick funds themselves, can expect these schemes to make an informed choice for them. These schemes should at least help avoid laggards. “Many times, investors take a long time to identify them. A process-driven approach helps in weeding out laggards,” says Mehta.

Rupesh Bhansali, Head-Mutual Fund, GEPL Capital says, “Fund of funds allocating to Nifty 50, Nifty Next 50 and Nifty midcap 150 indices ensure buying and selling of units of these ETFs in a seamless manner based on the relative attractiveness of these indices. If investors do it themselves, there would be operational issues such as placing orders and liquidity, as well as tax liability, which are avoided under the fund of fund allocator structure.”

Some also allocate money to thematic offerings. ICICI Prudential Thematic Advantage FOF invests in various sector funds of ICICI Pru AMC. Higher allocation to thematic funds can provide a return kicker, but can also increase risk.

Taxation of FoFs

These schemes, whenever they invest in index funds or other actively managed equity schemes, are treated like debt funds. Gains on investments held for more than three years are treated as long term gains and taxed at 20 percent after indexation. Gains on investments held for shorter term are added to income and taxed as per slab rate.

However, FOF investing in equity ETF are treated like equity funds. Hence gains on investments in schemes such as MAEF and IPPSF held for more than one year are treated as long term capital gains and taxed at 10 percent rate of tax if the quantum of long term capital gains for the financial year exceed Rs 1 lakh. Short term capital gains are taxed at 15 percent rate of tax.

Though schemes investing in ETF enjoy better taxation and relatively lower costs, compared to FOF investing in actively managed schemes do not jump to grab one.

What should you do?

FoFs investing in schemes of other fund houses give more options to choose from and can offer diversification in terms of size and investment management styles – growth, value, quality – compared to those deploying sums within their own AMCs.

Do-it-yourself investors can use these schemes for the core portion of their equity portfolio. “Conservative to moderate risk profile investors can consider these schemes with a five-year timeframe,” says Ravindra Deshmukh, Certified Financial Planner with Arthmitra Financial Services.

While investing, you should get your asset allocation right. These schemes can be used to achieve the equity allocation. You should not confuse them with schemes investing in assets such as equity, gold and bonds – multi-asset funds. Fund of fund arrangements mean higher expenses comparing compared to what you would incur if you invest directly.

These schemes can work for you meaningfully in the medium to long term, if you do not have access to an advisor.

Nikhil Walavalkar
first published: Apr 27, 2021 09:46 am