Illustration: Binay Sinha
At a time when asset classes like equities and gold have offered high returns and are trading near their all-time highs, investors often find it difficult to choose the right investments. In such a scenario, funds of funds (FoF) can be an effective tool for portfolio allocation. The recent fiscal changes in the budget have increased the attractiveness of these funds.
Mutual funds invest in units of other mutual fund schemes. The FoF fund manager chooses various schemes, depending on the FoF mandate. “Mutual funds are an extension of the reason investors come to mutual funds – to seek professional management. They offer a one-stop and convenient solution for investors,” says Chirag Mehta, Chief Investment Officer, Quantum Asset Management Company (AMC).
They offer the advantage of diversification. “By investing in a basket of funds, mutual funds can help minimise the impact of underperforming funds, thereby reducing the overall investment risk,” says Akhil Chaturvedi, Chief Business Officer and Managing Director, Motilal Oswal AMC.
Various investment mandates
Mutual funds come in various forms. Some are based on asset allocation, investing in a mix of equities, debt and commodities such as gold and silver. These schemes may have plans to suit different risk profiles – aggressive, moderate or conservative.
Some of them, such as equity mutual funds, are asset-specific: they can invest in domestic equity funds or in foreign mutual funds and exchange-traded funds (ETFs). Some mutual funds are limited to domestic funds, while others also allow investment in schemes belonging to other fund managers.
Mutual funds can invest in either active or passive funds. “Passive mutual funds serve to fill a gap in the portfolio of an asset class. For multi-asset or equity strategies, active mutual funds are preferable, given the inefficiencies of the Indian market, which offer the potential for long-term outperformance,” says Mehta.
Cost implications
Mutual funds invest in direct schemes of the target mutual funds, but charge their own expense ratio, resulting in duplication of costs. “One disadvantage of mutual funds is the additional layer of expenses that the investor has to bear,” says Parul Maheshwari, certified financial planner.
Mutual funds can also lead to over-diversification of an investor’s portfolio. “This could limit the potential for significant gains from individual high-performing assets within the portfolio or dilute the impact of better-performing funds,” Chaturvedi says.
Improving taxation
Changes in tax rules in the Union Budget 2024 have revived investor interest in mutual funds. Earlier, these schemes were taxed like debt funds, with gains (irrespective of the holding period) taxed at a flat rate. Post-Budget, mutual funds investing more than 90 per cent of their capital in equity ETFs are taxed at 12.5 per cent if gains are booked after a holding period of 12 months. Short-term capital gains (arising if units are held for less than 12 months) are taxed at 20 per cent. “Equity mutual funds have become more tax-efficient and are now treated on par with individual equity funds,” says Chaturvedi.
Take a long-term view
FoFs are ideal for first-time investors or those looking for a one-stop solution. “FoFs work well for do-it-yourself investors who don’t have the necessary knowledge or don’t want to make any changes to their portfolio themselves,” says Maheshwari.
Investors should take a minimum five-year perspective if they are going to invest in an equity-oriented financing fund.
First published: September 5, 2024 | 18:56 IS
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