Investing in a Fund of Funds: Taxation Treatment of FOF

Posted On Wednesday, Jun 22, 2016

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According to Investopedia, A Fund of Funds (FOF) - also referred to as a multi-manager investment - is an investment strategy in which a fund invests in other types of funds. This strategy invests in a portfolio that contains different underlying assets instead of investing directly in bonds, stocks and other types of securities. The versatility offered by this fund is akin to a cricketer who is able to bat anywhere in the order.
A Fund of Funds helps ease risk to a large extent by distributing investment across different funds.A Fund of Funds lowers the risk level of investments by investing fund in different kind of mutual funds. The taxation treatment of the fund is admittedly less than ideal.
Broadly, equity and debt are the two major areas of investments in the mutual fund industry. Both of them are taxed differently. All equity funds are in one tax bracket and all non-equity funds are in another tax bracket. Surprisingly, an equity fund of funds – which has equity funds as a part of its portfolio – is taxed as a non-equity fund!


Note the taxation differences in the table below:



Taxation on Mutual Funds in India

Type of Mutual Fund

Definition ofShortTerm & Long Term

Short Term Capital Gain Treatment

Long Term Capital Gain Treatment

Equity Mutual FundsHolding period of less than 365 days is short term
Holding period of 365 days or more is long term
15% tax under section 111A

Nil

Debt Mutual Funds (non- liquid schemes)Holding period of less than three years is short term
Holding period of three years or more is long term
Taxed as per individual tax slab of the investor20% with indexation is for resident individual and 10% without indexation* for NRIs
*Indexation is adjusting the purchase price for inflation. It increase the purchase cost and thus lowers the gain

An Equity-oriented fund, taxed as a debt fund

Taxation and investment go hand-in-hand. While considering investment opportunities, the first challenge that almost every investor faces is choosing among a plethora of options. The investor is also tasked with determining which of the options would be the most tax efficient. Equity Funds invest heavily in equities, which usually exceed 65% of their portfolio allocation. A Fund of Funds is a perfect combination of growth and diversification. The fund is eligible to classify as an equity fund as it invests only in the equity market. However, in reality, a Fund of Funds is taxed as a debt fund.
The mutual fund industry has argued that an equity fund of funds invests only in equities and thus such funds deserve the same tax rules that are applicable to all other equity funds.
The difference in opinion between the tax department and the mutual fund industry will hopefully end on a positive note for the industry. However, until such time, investors should consider a Fund of Funds as a good option for long-term investment, as can be seen from the performance of the Quantum Equity Fund of Funds:



Quantum Equity Fund of Funds Performance
Value of Investment of
Rs.10,000@
Date PeriodScheme Returns (%) ^Benchmark Returns (%) #Additional Benchmark Returns (%) ##Scheme Benchmark #Additional Benchmark ##
30-Jun-15 Last 1 Year

4.93

0.41

-2.81

10,493

10,041

9,719

30-Jun-14 Last 2 Years

11.06

6.04

3.07

12,337

11,246

10,624

28-Jun-13 Last 3 Years

22.6

14.73

11.62

18,460

15,121

13,920

^Past performance may or may not be sustained in the future. Load is not taken into consideration and Returns are for Growth Option. Returns up to 1-year period are absolute returns, returns greater than 1-year period are compounded annualized (CAGR).
#S&P BSE 200 INDEX ## S&P BSE Sensex
@ Shows the current value of Rs.10,000/- invested at the beginning of a given period

For other Schemes Managed by Mr. Chirag Mehta please click here.
A drawback of Fund of Funds is that an investor must pay the FoF manager a fee in addition to the fees charged by individual funds. But if one trusts the investment process followed by the FoF manager to astutely consider the fees of the funds in which it invests, then the additional fee paid for the FoF can be well worth it. Note that despite this additional layer of fees (which at Quantum is one of the lowest in the industry), the Quantum Equity Fund of Funds has outperformed its benchmark over the last three years.
Do not forget, equities have the potential to give the better  post-tax returns over the long term . Selecting the best funds and remaining invested for the long term is the only mantra for successful investors.


Stay invested!


Product Labeling


Name of the Scheme & Primary BenchmarkThis product is suitable for investors who are seeking*Risk-o-meter of Scheme
Quantum Equity Fund of Funds

An Open Ended Fund of Funds scheme Investing in Open Ended Diversified Equity Schemes of Mutual Funds
• Long term capital appreciation

• Investments in portfolio of open-ended diversified equity schemes of mutual funds registered with SEBI whose underlying investments are in equity and equity related securities of diversified companies
Quantum Equity Fund of Funds
Investors understand that their principal will be at Very High Risk

* Investors should consult their financial advisers if in doubt about whether the product is suitable for them.

Disclaimer:

The views expressed in this article are the personal views of the Fund Manager of Quantum Gold Fund. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. This information is meant for general reading purpose only and is not meant to serve as a professional guide/investment advice for the readers. This article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.

Above article is authored by Quantum.

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