Fund of funds is available as a distinct product in the Indian mutual funds space. But the concept of fund of funds (FOF) has not really picked up in a big way in India. If you look at the more developed markets of Asia, Europe and the US, the FOFs are primarily used as a source of providing advisory services to the customers. The reasons are not far to seek. You have FOFs on equity, debt, gold, metals and even on global indices. As an investor you just need to tweak your FOF mix in such a way that you are able to create a diversified portfolio that is not only opportunistic but also gives you the best risk-adjusted returns. All that is possible with FOFs!

In India, FOFs have typically predominated in the area of international funds. Indian AMCs with global affiliations used to structure FOFs inn such a way that they would collect funds from Indian unit holders and reinvest the funds in the global index funds of their international partners. This gives international diversification to the domestic portfolios and also gives investors an additional asset class to invest. The international funds have been preferred because they are not exactly correlated with the local markets. Let us look at some interesting ways as to how you can actually put FOFs to use …

Firstly, FOF offers indirect participation in ever alien markets and complex markets where you can use the FOF as an allocation mechanism. FOFs can be your ticket to participate indirectly in global markets. Most investors are either predominantly or entirely exposed to the Indian market and are constantly worried about a possible downturn in the Indian markets. The fund performance could get negatively impacted. That is where the international funds (FOFs) come in handy. They give you the ability to take positions in beta-only global indices so you obviate the company specific risks. Additionally, the global index also saves you the hassles of currency risk.

Secondly, you have a wide choice of FOFs available to you in the market. In fact, there is a virtual array of FOFs available to you in the global market. FOFs offer you a wide choice of international markets and international asset classes. You get an automatic hedge into your portfolio. For example, at a time when the dollar is rapidly strengthening, you can use international FOFs on US indices to give you the dollar advantage. There are FOFs you can invest that are dedicated to commodities like gold, silver and other asset classes. This helps you to participate in the commodity up cycle and also de-risk your portfolio risk which is predominantly tilted towards equities. Then, of course, there are FOFs which invest predominantly in commodity indices or bond indices so you do not take the specific risk but you can invest in themes. For example, you can get ETFs to trade in themes like ferrous, non-ferrous, precious metals, industrial metals, energy, clean energy, credit quality, distressed assets, long duration etc.

In India, FOFs are not used very aggressively in financial planning but across south East Asia, Europe and the US these FOFs are quite popular as financial planning tools. As a financial planning tool, FOFs are unmatched. If you have decided to opt for a financial solution based fund for your retirement or your child’s education, then FOF is what you are getting into. Most of these solution oriented funds are nothing but FOFs. In more matured markets, FOFs are a very important tool of financial planning. Essentially financial planning is about achieving your goals through intelligent asset allocation. But what do you do if you are not able to get your appropriate mix. That is where FOFs can come in handy. In other countries advisors purely specialize in combining FOFs to give you the risk-return matrix that is suited to your unique requirements. Using FOFs for financial planning is not only economical but also intelligent because you are getting the flexibility to meet your financial goals in the simplest possible manner.

FOFs make you portfolio non-directional and better diversified. Long term portfolios normally tend to be long only portfolios. That is the catch. You are stuck to long positions even when markets correct sharply with the result that you spend a lot of time recovering your losses and recouping the MTMs. In FOF based investing, you can tweak your portfolio by just tweaking from one FOF to another. You have a choice between debt, commodities, energy, precious metals, global indices, bond indices etc.

The disadvantage of an FOF in the Indian context is its tax treatment wherein the FOF is treated as a non-equity fund even if it is a fund of equity funds. That is a major anomaly and the fund industry has been trying to reason with the IT authorities to change that. Effectively, FOFs will be treated as short term gains if held for less than 3 years and long term gains only beyond that. In case of FOFs, the STCG is payable at your peak tax rate and the LTCG is payable at 20% after indexation. Unless this anomaly is rectified, FOFs may not really attract the attention of investors and financial planners in India. There is also an aspect of cost in FOFs because costs tend to get loaded on the end customer at two levels. This is again something SEBI must look to tweak favourably.