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Investing in a fund of funds

Ashutosh Gupta sheds light on the factors to consider while investing in a fund of funds

What is your view on a fund of funds? How about Axis All Seasons Debt FoF for a five-year investment horizon?
- Jayan Machingal

There are several issues to consider when considering a fund of funds. First is that they generally make more sense for an investor who is looking to invest only in one fund. This is because a fund of funds holds several funds and if you have it as just one of your holdings among several funds, you end up being a fund collector. So, it doesn't really help and only contributes towards diluting your returns.

Secondly, a lot of FoFs invest only in funds of the same fund company and that is not desirable. So, while you end up investing in many funds, you don't really diversify across AMCs. So FoFs, which invest in funds of the same fund company, score low from that perspective.

Third important consideration is taxation. FoFs, even those which invest in equity funds, get taxed as debt funds. Therefore, your tax liability tends to be on the higher side. So, that's a disadvantage that they have from a taxation point of view.

Finally, the last consideration is cost. You add another layer of cost when you're talking about FoFs. This is because you end up incurring the expense ratio of the underlying funds and on top of it, there is a certain degree of expense ratio which the FoF itself would be charging.

These are the reasons behind the fund of funds not taking off in a big way and their asset size continually remaining fairly low.

Now let's talk about Axis All Seasons Debt FoF and evaluate it on these discussed parameters. First, in terms of diversification, I think there are no issues because it's one of those FoFs which invests in funds of other fund houses as well. In fact, Axis funds account for about 25 per cent of its portfolio. So, it does pretty fine on that parameter.

Next, we talk about taxation. There is no specific disadvantage that this fund has, because anyways it invests in debt funds and fetches the tax treatment of a debt fund. So, there is no disadvantage because of its structure of a FoF.

But the direct plan of this fund comes at a cost of about 0.22 per cent, which is on top of the expenses of the underlying funds. Costs are particularly more relevant in the case of debt funds where they can burn a bigger hole in your overall returns. So, cost is one aspect where this fund scores low.

Even otherwise, if we look at underlying investments of this fund, it has about 40 per cent of its assets in credit-risk funds, which is far too high for our liking. So, I would suggest you can avoid this fund and look for other alternatives.

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