Monday, February 01, 2010

Fund of Funds

One-stop shop…

Marketed as an investment one-stop shop, multi-manager funds are designed to make an investor’s life easier by bringing together a range of specialist managers into a single fund. There are two types of multi-manager funds: those that invest in funds which are called Fund of Funds (FoF) and those which invest in shares through appointed investment managers called Manager of Managers (MoM).

…offering the ‘best’ of the best

Many fund houses have tried to tap investors with fund of funds — an offering that is an amalgam of the best performing funds. The portfolio of fund of funds offers benefits of diversification into different funds comprising of asset types like equity/debt/money market instruments and even non-financial assets.

Fund houses such as Birla Sunlife Mutual Fund, Franklin Templeton India Mutual Fund, ICICI Prudential Mutual Fund, ING Vysya Mutual Fund (brand name of Optimix), and Kotak Mutual Fund that offer FoFs have a longer track record in the Indian market and a relatively larger universe of schemes to choose from within their respective fund house. Birla, for instance, has over 15 open ended equity funds in its stable. Others, such as the more recently launched Fortis Multi-Manager Fund, provide the flexibility to invest in other fund house schemes as well. In this context, Fidelity, at present, has about four equity funds and a similar number of debt funds under the Indian AMC. Further, investment strategy (in equity) across Fidelity funds (although with different themes) is not too divergent as most of them follow a bottom-up stock picking approach without any sector or market-cap bias in even some of the schemes. However, the fund house has stated that it plans to invest in future schemes of Fidelity India as well as in the schemes of Fidelity International. The recently launched (January 2010) Fidelity Global Real Assets Fund is an open-ended fund of funds scheme that combines thematic thinking and a bottom-up stock idea selection. The fund looks to generate growth from a portfolio invested in Fidelity Funds – Global Real Assets Securities Fund, which is an offshore fund. The Global Real Assets Securities Fund invests in equity securities all around the world leading to a diversified exposure spanning commodities, property, industrials, utilities, energy, materials, and infrastructure.

The gloom in the glitter…

Many FoFs were able to limit their losses at the height of the global financial crisis when markets went into a tailspin. For example, while the worst performing equity diversified fund had lost 80 per cent and the Sensex had lost 50 per cent, the worst FoF had lost only 45.47 per cent. Given their flexibility to increase debt allocation, a good number of equity FoFs held debt/cash and cash equivalents. This appears to be the reason for their relatively better performance compared to diversified equity funds that cannot go too high on debt.

But the scenario changes when one compares the best performing funds. Birla Sun Life's Asset Allocation Aggressive (FoF) was among the best performers with returns falling 31.38 per cent. UTI MNC, the best performer in the equity diversified category, has lost slightly less at 31.05 per cent. The returns are quite comparable. In the case of debt schemes, the scenario is slightly different. While the best bond and gilt funds have returned almost 30 per cent, the best returns from a FoF scheme in this category is just 17.14 per cent.

The returns certainly do not justify the claims that FoF managers make, especially because of the higher fund management cost. All FoF schemes charge an expense ratio that is 0.35 - 0.75 per cent more than equity and debt funds. And that is simply because there are two expenses involved – one charged by the FoF and another charged by the schemes where the money is invested.

The big deterrent is that FoFs are classified as debt funds for tax treatment irrespective of whether these funds invest in equity or debt. The tax on short-term capital gains is 30% as opposed to 15% in the case of equity funds. The tax on long-term (over one year) capital gains is 10 per cent without indexation and 20 per cent with indexation. On the other hand, there is no long-term capital gains tax on equity diversified funds. FoFs cannot, therefore, match the returns of equity funds over a longer period of time.

Besides returns and tax issues, the investment style of funds is also an issue. At present, only ING Optimix, Fortis, and Kotak invest in schemes of other funds. The rest prefer their own fund’s schemes. In addition, the fund manager is allowed to shift between funds during the year to enhance returns. Under such circumstances, the entire objective for investors, who are willing to pay a bit more for best results, is defeated. The investor is only exposed to fund management style and risk outlook of a single asset management company.

All said and done, the average AUM of FoFs rose from Rs 749 crore in January 2009 to Rs 1,044 crores in December 2009. Moreover, the purchase of FoFs has surpassed redemptions since May 2009. This is, indeed, a welcome development.

Why traverse the fund of funds route?

Globally, fund of funds and manager of managers are gaining increasing recognition as viable and undeniable investment opportunities. The recent launch of Fidelity Global Real Assets Fund and the impending launch of three gold Fund of Funds by Benchmark, Reliance, and UTI bear testimony to the fact that India will not be left far behind. Reversal in the tax anomaly regarding FoFs and a broader view by some funds which confine themselves to only their own funds and remain ‘fettered’ will definitely offer a fresh lease of life to FoFs and build a strong case for treading the FoF route, which undoubtedly makes immense investment sense.

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