Fund of funds schemes falter on returns

In the last couple of years, many fund houses have tried to tap investors with fund of funds (FoF) — an offering that is an amalgam of the best performing funds.

So it’s no surprise that many FoFs have been able to limit their losses in the last one year when markets went into a tailspin. For example, while the worst performing equity diversified fund has lost 80 per cent in the last one year, the worst FoF has lost only 45.47 per cent.

But the scenario changes when one compares the best performing funds.

Birla Sun Life's Asset Allocation Aggressive (FoF) is 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 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.
 

COMPARITIVE RETURNS
FoF (Equity)	Returns (1-yr)
Birla Sun Life Asset Allocation Aggressive	-31.38
FT India Life Stage FoF 20s	-37.05
ICICI Prudential Advisor-Very Aggressive	-43.89
ING OptiMix 5 Star Multi Manager FoF	-44.39
ING OptiMix Equity Multi Manager FoF	-45.47
Equity Diversified Fund	Returns (1-yr)
UTI MNC	-31.05
Birla Sun Life Dividend Yield Plus	-32.22
UTI Dividend Yield	-33.07
IDFC Imperial Equity	-35.61
UTI Contra	-37.09
(All returns as on 03 Feb 2009),               Source: Value Research

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

Hemant Rustagi, chief executive officer of WiseInvest Advisors, said the big deterrent is that these funds are classified as debt funds for tax treatment. That implies that whether these funds invest in equity or debt is irrelevant.

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.

According to a senior fund manager in ICICI Prudential, FoFs cannot match the returns of equity funds over a longer period of time. If one considers three-year numbers, they are not that impressive. That is, while ICICI Prudential Infrastructure Fund has returned 8.65 per cent a year in the last three years, Birla Sun Life’s AAF Aggressive (FoF) plan has returned 2.35 per cent a year.

Besides tax issues and returns, many believe that the investment style of funds is also an issue. At present, only ING Optimix invests in schemes of other funds. The rest prefer their own fund’s schemes.

The Rs 749-crore fund of funds (FoF) schemes either invest in their own best funds or those of other asset management companies (AMCs).

For instance, ICICI Prudential invests in its own schemes, while ING Optimix invests in funds of other AMCs. Also, the fund manager is allowed to shift between funds during the year to enhance returns.

In such circumstances, the entire objective for investors, who are willing to pay a bit more for best results, is defeated. “The person is only exposed to fund management style and risk outlook of a single asset management company (AMC),” said Dhirendra Kumar, chief executive officer, Value Research, a mutual fund research agency.