Building an efficient portfolio of wealth creating mutual funds is often seen as a daunting task by many of you investors. We too agree that it's not easy, as host of factors are involved and extensive data analysis need to be performed in order to have consistent performers in the investment portfolio so thatthe edgy feelingis refrainedfrom creeping in when the equity markets experience a downturn.
While some of you may say - "enough data is available on the internet" (on various websites) and I can go by star rated mutual funds, or "my mutual fund distributor / agent / relationship manager provides me with a good advise"; we believe that you or your mutual fund distributor may not have the skill sets for prudent extensive mutual fund research. And mind you there is more to mere assessment of past returns in the process of selecting winning mutual funds. It's noteworthy that it also involves analysis offactors such as:
- Performance of peers in the category
- Performance of the fund under consideration across phases of market cycles
- Risk which the fund has exposed it investors to
- Risk-adjusted returns
- Portfolio characteristics (i.e. top-10 stock holdings, top-5 sector exposure and portfolio turnover ratio)
- Costs of investing (i.e. expense ratio and exit load)
- Investment processes and systems
Moreover, one can't rule out the fact that with vast number of schemes available confusion can mount thusmaking the task of selecting winning mutual funds portfolio more complex and dilemmatic.
Even those of you who are research oriented in your investment approach, the time and moneyspent (if source from a mutual fund research agency) makes it an expensive proposition. Also while you have selected winning mutual funds for your portfolio, makes not only tracking of the mutual fund schemes necessary but also leads to multiplicity of transactions, filling forms and maintain multiple account statements.
Hence given the aforementioned intricacies involved,while holding a portfolio of winning mutual funds may appear dispiriting, you have the comfort of enjoying a diversified portfolio of winning mutual funds by investing in a good Fund of Fund (FoF) scheme.
A FoF offers investors an excellent and a unique investment proposition, as it is a mutual fund scheme that invests in schemes of other mutual funds(thereby taking the concept of mutual fund investing to another level). While a mutual funds fund manager invests in stocks of various companies, a FoF scheme's fund manager invests in the schemes of their own fund house or a third party fund house(s) which may either be domestic or international. Hence, given the investment strategy FoFs follow, they allow you investors to hold a single product of various mutual funds rather than direct investing in various regular mutual fund schemes.
At present there are 108 FoF schemes, of which 70 are equity ones, 31 debt and 7 in the hybrid category.
Report card
(NAV data is as on Aug 30, 2011. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be 6.37%)
(Source: ACE MF, PersonalFN Research)
As far as their performance is concerned, most of equity oriented FoFs led by the domestic equity oriented ones have delivered luring returns across time frames and also well managed their risk (as revealed by their Standard Deviation) which thus has resulted in them providing appealing risk-adjusted returns (as revealed by their Sharpe Ratio). However while investing in them, we believe that you should not just get lured by the past performance they have delivered, but also delve a litter deeper to ascertain the following aspects:
Investment objective and asset allocation as mandated for investment Track record of the underlying mutual fund schemes in its portfolio Portfolio of stocks and sectors which the underlying funds have an exposure to Investment processes and systems followed by the fund manager while choosing the underlying funds
Also you need to assess the tax implication of investing in a FoF scheme, as this would have an impact on the post-tax returns which you earn on your investments. It noteworthy that FoFs are classified as a debt scheme for taxation purpose (despite investing even 100% of its corpus in equity oriented mutual fund), whereby the short-term capital gains (connoted if holding period is less than 1 year) which one earns is taxed as per the marginal rate of taxation (i.e. as per one's tax slabs)while the long-term capital gains (connoted if holding period is greater than 1 Year) is taxed @ 10% without availing the benefit of indexation, or 20%by availing the benefit of indexation.Moreover, the dividend which one earns (if opted for the dividend option), is subject to a Dividend Distribution Tax (DDT) @ 13.519% (12.5% DDT + 5.0% surcharge + 3% education cess).
| Investor Category |
Short Term Capital Gains Tax
(Period < 1 Year) |
Long Term Capital Gains Tax
(Period > 1 Year) |
Dividend Distribution Tax |
TDS |
| 2010-11 |
2010-11 |
2010-11 |
2010-11 |
| Resident Individual / HUF |
As per Tax Slab |
10%
(20% with Indexation) |
13.519%
(12.5% + 5.0% surcharge + 3.0% education cess) |
Nil |
| Partnership Firms / AOP / BOI |
30% |
10%
(20% with Indexation) |
32.445%
(30% + 5.0% surcharge + 3.0% education cess) |
Nil |
| Domestic Companies |
30% |
10%
(20% with Indexation) |
32.445%
(30% + 5.0% surcharge + 3.0% education cess) |
Nil |
| NRIs |
As per Tax Slab |
10%
(20% with Indexation) |
13.519%
(12.5% + 5.0% surcharge + 3.0% education cess) |
STCG - 30% ^
LTCG - 20% ^
(After Providing for Indexation) |
^Plus applicable surcharge and secondary and higher education cess.
(Source: Finance Act, 2011 PersonalFN Research)
Hence while the from a taxation angle it may appear a little discouraging, a FoF schemeimbibes in it pros of investing as well which are:
- Opportunity to create a diversified portfolio of various mutual funds schemes where one can build a portfolio and avail the benefit through:
- Diversification by fund manager
- Diversification by style of fund management followed by the funds in the portfolio (i.e. value, Growth, blend, opportunities, flexi-cap, multi-cap and thematic)
- Reduction in risk exposure due to diversification (as seen above)
- Research and process of selecting the right mutual fund schemes is taken care by the FoF fund manager
- Multiple fund managers and mutual fund schemes in the underlying portfolio, helping to reduce the impact of bad performance by any of the fund manager or the fund
- Reduces hassles such as multiplicity of transactions, filling forms, maintain multiple account statements and tracking multiple mutual schemes - all experienced while investing directly in regular mutual funds schemes .
But before you invest in a FoF, you need to check whether the investment objectives and the asset allocation followed, suits your investment objectives as well. Also you need to be ready to bear the high net expense fee (which is higher than regular equity oriented mutual fund schemes),as an FoF pays the fee both at its level as well as on the underlying mutual fund investment schemes in which it is invested in.
The verdict:
Hence given the aforementioned pros and cons,aFoF scheme is a worthwhile investment proposition for:
- Small investors willing to build a portfolio of quality mutual funds
- Investors who are new to mutual funds and lack resource of researching and choosing the right funds
- Investors who want to eliminate the cost incurred on research and advise on investment in regular mutual funds
- Investors who want to eliminate the hassle of maintaining and tracking their investment in multiple schemes
This article was written exclusively for Equitymaster, India's leading Independent research initiative. Trusted by over a million members all over the world, Equitymaster is known for its well-researched, unbiased and honest opinions on the Indian Stock Market.
Disclaimer: This note / article is for information purposes and Quantum Information Services Limited (PersonalFN) is not providing any professional / investment advice through it. The recommendation service, views, articles and other contents are provided on an "As Is" basis by PersonalFN. The facts mentioned in the note are believed to be true and from a public source. The Service should not be construed to be an advertisement for solicitation for buying or selling of any scheme / financial product. PersonalFN disclaims warrants of any kind, whether express or implied, as to any matter/content contained in this note, including without limitation the implied warranties of merchantability and fitness for a particular purpose. PersonalFN and its subsidiaries / affiliates / sponsors / trustee or their officers, employees, personnel, directors will not be responsible for any direct/indirect loss or liability incurred by the user as a consequence of his or any other person on his behalf taking any investment decisions based on the contents of this note. Use of this note is at the user's own risk. The user must make his own investment decisions based on his specific investment objective and financial position and using such independent advisors as he believes necessary. PersonalFN does not warrant completeness or accuracy of any information published in this note. All intellectual property rights emerging from this note are and shall remain with PersonalFN. This note is for your personal use and you shall not resell, copy, or redistribute this note, or use it for any commercial purpose. Please read the terms of use.
Add Comments
| Comments |
ahernandez@utn.ac.cr
Nov 03, 2011
Wow, that's a really clever way of thinking about it! |
dagmarelle@omhem.se
Sep 29, 2011
This does look promising. I'll keep coming back for more. |
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