Monday, February 02, 2009


FUND FLAVOUR - Fund of Funds
(February 2009)

Prescription …

In volatile and uncertain markets diversification and rebalancing of the portfolio on an ongoing basis are crucial in order to enhance returns or minimize losses. Fund of Funds (FoFs) or Multi manager Funds may just be what the doctor ordered as it simplifies the investment process for investors who normally have to invest in a range of mutual funds to achieve their desired asset allocation. FoFs make the investment process much easier for investors on account of their rebalancing feature, as normally, market movements make their steady state asset allocation go awry, and frequent rebalancing is cumbersome and inefficient from a tax perspective. Moreover, the different options in the FoFs make them an ideal investment avenue for investors and distributors seeking a ‘one-stop’ shop for their investment needs.

The Multi manager advantage

Multi manager funds aid long term wealth creation through comprehensive diversification, convenience and affordability and are active at all stages – from setting objectives, asset class selection, strategic asset allocation, portfolio construction, manager selection, tactical asset allocation, active manager allocation to monitoring and review.

Team players at premier prices

Multimanagers can switch rapidly between funds as their fortunes wax and wane. Like a wealthy football club, they can sign up the best players in the game – and such a galaxy of talent should, in theory at least, deliver a superior performance. However, as those who pay star footballers can tell you, such talent does not come cheap, saddling investors with a huge burden. Investors purchasing multimanager funds have to fork out two layers of charges: one for the multimanager doing the fund selection and another for the underlying funds.These funds have a tax structure similar to debt mutual funds, irrespective of the exposure they have to underlying funds, equity or debt. So, investors pay a short-term capital gains tax at 30% and long-term capital gains tax of 10%, or 20%, with indexation (applicable surcharge and cess to be added to the tax rates). A dividend distribution tax of 12.5% for retail investors and 20% for institutional investors is payable on debt funds.

A Motley mixture

FoFs offer off the shelf asset allocation. A ready made asset allocation solution compared to investing directly in a varying portfolio of shares, bonds and mutual funds saves time. A critical evaluation of FoFs vis-a-vis equity funds have revealed that FoFs have a better Standard Deviation (risk) but score low on the Sharpe Ratio (risk-adjusted return) front. Corpus size, investment in funds across the industry and performance vis-s-vis the benchmarks are other key criteria in the selection of FoFs. FoFs lag in performance in a broad based bull market. The bull market of 2007 made it difficult to outperform the index. In the 2008 downmarket these funds managed to preserve their capital since they had allocated a lion’s share to liquid and debt funds in their portfolio. Close to 75% of the FOFs outperformed the BSE sensex. As FOFs can take asset allocation calls, funds with flexible debt and equity mix, can take advantage of such market conditions. The figures speak for themselves:

How FoF scores over other Funds

Fund type 3 mths (%) 6 mths (%) 1 yr (%)

Figures are category average returns as on 31 October 2008

A sojourn not so smooth

FoFs, though sound conceptually, have a long way to go in India. All the FoFs combined have a corpus of Rs 896 cr. This is miniscule compared to the total AUM in the entire mutual fund universe. Despite the advantages they offer, FOFs have not caught on with the average investors. This is like a fill-it-shut-it-forget-it investment vehicle. It is interesting to note in this context that, multimanager funds are hugely popular in the US and Europe in particular. Multimanager investing is the hottest trend in the financial services industry in the US and Europe enticing asset managers to loudly tout their wares. But Indian FoFs are relentless despite the lack of recognition.

Daring dream

ING Group expects assets under its multi-manager products in India to surge five times to 50 billion rupees ($ 1.1 billion) in three years as the strategy attracts retail and institutional money. The firm launched the strategy in India in 2006 and now has about 10 billion rupees from investors in India and AsiaPacific region, while those from Europe and Middle East were interested. The number should easily be five times its size in the next three years, with room to grow further. ING manages about $10 billion globally under its OptiMix division. The fund plans to launch 2-4 multi-manager products in 12 months, including globally-invested funds. Brisk demand for multi-manager funds is expected as professional managers look for such products in a volatile Indian market and rising complexity in domestic funds industry makes taking investment decisions tough for retail investors.

…in times of panic

During an economic slowdown or recession, it is not advisable to follow a fixed investment style in mutual funds as it can be detrimental to the fund's performance. In such a scenario, one should diversify across investment styles or multiple investment portfolios. Fund of Funds is a category of mutual funds that provides such benefits in times of panic.

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