FoF: Should you invest in them now

The changes in the tax structure of the mutual fund space in the last budget has given some unexpected results. Although fund of funds (FoF) was launched in India some time back, there were not many takers for this category of funds. FoF invests in other funds just like normal MF schemes invest in equity and debt of other companies. One of the reasons for such lacklustre interest in FoF was dis-advantageous tax incidence of FoF compared to normal mutual fund schemes. While dividends and long-term capital gain (LTCG) from equity schemes were tax-free till FY18 and before their re-introduction in the latest union budget, investors were forced to pay tax on LTCG from FoFs, even if the FoF portfolio comprised of equity funds.

Nonetheless, now as both types of funds is almost at the level playing field (at least in tax structure), we are witnessing increased interest of investors towards FoFs. Despite, domestic mutual fund industry witnessing a sequential drop in total AUM for the month of May 2018, FoF saw a marginal increase in their AUM.

One of the reasons for such increase in their AUM is better performance of these funds in the last six months. Their category average return is better than large-cap category average returns in the same period. While large-cap funds have given a negative return of 1.2 per cent in the last six months, FoF in the same period has given a return of 1.8 per cent.

Besides, FoFs have now gained a unique advantage over equity mutual funds as they can churn the funds in their portfolio without any tax incidence. Since there won’t be any tax incidence till the FoF is redeemed, investors can reap the benefit of portfolio rebalancing without paying for that.

Does this mean that you should invest in FoF? Inspite of better returns of late, investors are advised not to rush for FoFs. They should ask all those relevant questions that you do before investing in any MF scheme such as if the objective of the FoF is in sync with your investment objective. Go for an experienced fund manager and know your risk tolerance and tax implications before investing in FoFs.