What is Equity Fund of Funds? An Equity-oriented fund, taxed as a Debt Fund!

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:

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 :

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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 substantially 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.

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed 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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