Diversifying risk with Fund of Funds

Representational image.

Representational image.   | Photo Credit: K. Pichumani

Such a fund invests in other MF schemes

What is a Fund of Funds?

Just like a mutual fund (MF) scheme invests in shares of listed companies, a Fund of Funds (FoF) is a scheme that invests in units of other MF schemes.

Simply put, FoF is an MF scheme but one that does not invest directly in stocks or securities but in other MF schemes. In India, only a few fund houses offer FoF schemes that allow the investor to diversify the risk across schemes or fund managers through a single fund. Some fund houses that have FoF schemes in India are Quantum Mutual Fund, HDFC Mutual Fund and Franklin Templeton, among others.

What are the advantages of investing in an FoF?

The biggest advantage is, it gives the investor an opportunity to invest in different schemes managed by different fund managers. At times, this approach may work better since different fund managers might have have different expertise in terms of investing in large-caps, small-caps or mid-caps. With a single FoF, the investor will be able to benefit from the diverse investment approach. While most MF houses invest in their own schemes through an FoF, there are some that also invest in other fund houses’ schemes thereby offering more diversity. For instance, the FoF scheme of Quantum Mutual Fund invests in schemes managed by Kotak MF, ICICI Prudential MF and Aditya Birla Sun Life MF.

How are gains from FoF investments taxed?

For tax purposes, FoF is treated as a non-equity fund even though most FoF schemes invest in equity-oriented funds.

As a result, gains arising out of FoF investments do not get the benefits that an equity scheme gains derive. For instance, in equity schemes, if the units are held for more than 12 months, then no short-term gains tax is applicable.

But, in debt and debt-oriented funds, the units have to be held for over 36 months to avoid short-term gains tax. Incidentally, in its pre-Budget memorandum, AMFI suggested that the definition of ‘equity oriented funds’ (EOF) be revised to include FoF investments as well, which would lead to such investments getting the same tax benefits that an equity or an equity-oriented scheme enjoys.

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Printable version | Feb 27, 2020 1:01:33 AM |

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