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Investing in mutual fund? Five reasons to go for equity Fund of Funds

As a result, the risk involved in the journey of wealth creation is mitigated and the gains are optimised for the investor. (Illustration: Rohnit Phore)

By Jimmy A. Patel

Diversification is one of the basic tenets of investing. The objective is to build an efficient portfolio of wealth-creating mutual fund schemes, whereby investors achieve their envisioned financial goals with the risks mitigated, particularly when investing in equities.

Here are 5 key reasons to consider an equity-oriented Fund of Funds (FoF):

Multidimensional diversification
Investing in equity FoF offers extra layers of diversification across fund management styles, across market capitalisations, and multiple fund managers. As a result, the risk involved in the journey of wealth creation is mitigated and the gains are optimised for the investor.

Professional fund management
The fund manager carries out comprehensive research, applying quantitative and qualitative parameters to pick the best mutual fund schemes. Under quantitative analysis, the focus is on performance (returns + risk) across time frames (1-year, 3-year, 5-year, since inception) and market cycles (i.e. bull and bear phases). Under qualitative aspects emphasis is on the portfolio characteristics, proportion of AUM actually performing, funds-to-manager ratio, track record of particular fund manager, the investment processes and systems at a respective fund house, etc.

Portfolio monitoring and review
As a part of the fund management activity, the health of the portfolio is tracked as well; not just to achieve the investment objective of long-term capital, but to outperform the benchmark returns and provide better returns.

If the equity FoF has not been able to achieve that over time, then the fund manager actively prunes the holdings to weed out the duds and replace them with well-deserving and better performing schemes to make sure the investors' portfolio is on track to accomplish the envisioned financial goals. This, therefore, eliminates the hassle of picking and tracking investment in multiple schemes for a financial advisor.

Units held in demat mode
The units of an equity FoF can also be held in a dematerialised (demat) mode as in stocks and other mutual fund schemes. This makes transacting and tracking the portfolio easy as opposed to keeping track of physical account statements.

Reduce cost of investing
Usually, the expense ratio of a well-managed equity FoF from a process-driven fund house is low. As opposed to investing in multiple schemes with separate folios and attract an expense ratio for each, the equity FoF is a smart way of investing in multiple schemes and keep the cost of investing low.

However, an equity FoF scheme is classified as a non-equity scheme-i.e., debt-oriented scheme from taxation angle. Short Term Capital Gains (STCG) on holdings for up to less than 35 months will be taxed as per the marginal rate of taxation applicable to the investor/ client, as per his/ her income tax slab.

The Long Term Capital Gain (LTCG), on the other hand, on gains of units held for more than 36 months and above attracts a 20% tax with indexation. With the indexation benefit, the investor can counter inflation even if his/her purchasing power may not have changed. If the equity-oriented FoF has generated appealing returns, the effective post-tax returns can be rewarding.

The writer is MD & CEO, Quantum Asset Management Company