FUND OF FUNDS EXPLAINED: UNDERSTANDING TAXES, INVESTMENT OPTIONS, AND STRATEGIES
Introduction
A Fund of Funds (FoFs) is a mutual fund that invests in multiple other mutual funds or exchange-traded funds (ETFs) rather than directly in stocks, bonds, or other securities. Offering a range of investment options, FoFs come in various categories, catering to different investor interests and offering diversification. However, understanding tax implications and FoF taxation policies is critical as it can impact returns, affecting what you earn on your investment. This article will give you deeper insights into how FoFs are taxed and how you can take smarter decisions to optimize your tax liabilities and returns.
Features and Benefits
- FoFs provide investors with immediate diversification, spreading their investments across various funds, asset classes, and sectors.
- FoFs are economically viable, can be cost-effective, and can help you build a broad, diversified asset allocation beyond equity and debt, thus reducing risk.
- FoFs offer novice investors the opportunity to work with seasoned fund managers, saving time, effort, and individual research and decision-making.
FoFs in India and Taxes
- Mutual funds are classified in India as equity-oriented or ‘other than equity-oriented,’ depending on their portfolio assets’ composition. For a fund to be categorized as equity-oriented, it must invest at least 65% of its assets in stocks or equity-related instruments.
- FoFs have stricter criteria and would be classified as equity-oriented only if they invest at least 90% of their assets in ETFs, and these ETFs in turn, must invest a minimum of 90% in listed domestic shares of Indian companies.
- Investors should understand these rules as they affect how gains from these funds are taxed. Equity-oriented FoFs are taxed at 15% flat, regardless of tenure, listed under section 111A read with section 50AA of the Income-tax Act.
- However, if an FoF does not meet the 90% ETF investment criteria, it is considered ‘other than equity-oriented.’ In such cases, the FoF will have debt taxation.
Investing in FoFs: Pros and Cons
- FoFs offer a hassle-free, diversified portfolio that is managed by professionals, making it easy for novice investors to navigate.
- Investing in FoFs may lead to higher expense ratios, as the FoF expense ratios must account for the costs linked with the underlying funds.
- FoFs may not always be the right investment option for every situation or investor profile.
Conclusion
FoFs offer several advantages, such as helping investors diversify their investments and reduce risks while providing an opportunity for novice investors to work with qualified fund managers. However, it is crucial to undertake your research and careful study of FoFs’ tax implications before investing.
Recent Developments:
- Section 50AA of the Income-tax Act introduced last year states that any redemption from funds with less than 35% invested in shares of domestically listed companies is treated as a short-term capital gain.
- Similarly, a new regulation rolled out by the Securities and Exchange Board of India (SEBI) in January 2021, limits the exposure of multi-cap mutual funds to up to 25% of an individual stock, ensuring portfolio diversification and protecting investors’ interests.
Key Takeaways:
- FoFs are mutual funds that invest in other mutual funds or ETFs rather than directly in securities.
- FoFs offer several advantages, including immediate diversification, professional fund management, and risk reduction.
- FoF taxation policies differ between equity-oriented and ‘other than equity-oriented’ FoFs.
- Investors should carefully compare expense ratios before investing in FoFs.
- Follow new developments in regulations, such as those rolled out by SEBI, when making investment decisions.
Estabizz Fintech compiled the material in this article using the most recent Acts, Rules, Circulars, Notifications, Provisions, Press Releases, and material applicable at the time. They ensured the completeness and correctness of the material through due diligence. When using this material, users must consult the relevant, applicable legislation. The given data may change without prior notice and does not constitute professional advice. Estabizz Fintech disclaims all liability for any results from the use of this material.
