Life-cycle funds: Match goals with tenure, pick glide path for your risk

Wait for greater clarity on how these funds will be taxed at maturity

The Securities and Exchange Board of India (Sebi) has launched a new category of mutual funds called life-cycle (LC) funds. These are target-date mutual funds that automatically change asset allocation as the fund approaches maturity, thereby carrying out the rebalancing that many investors fail to do themselves.

 

“LC funds are designed for goal-based investing. They automatically manage asset allocation for the investor,” says Radhika Gupta, managing director and chief executive officer (MD & CEO), Edelweiss Asset Management.

 

Risk management 

A core advantage is automatic asset-allocation management, which can reduce behavioural errors. “These funds bring discipline and systemisation to the process of reducing equity exposure as the goal approaches,” says Gupta.

 

Investors who hold separate equity, debt, and commodity funds have to pay tax each time they rebalance their portfolios. “In LC funds, since the rebalancing happens within the fund, investors do not face taxation each time the allocation is adjusted,” says Gupta.

 

These funds will also offer the benefit of diversification. “Investors will be able to diversify into multiple assets, including equity, debt, gold and silver exchange-traded funds, and infrastructure investment trusts (InvITs), without having to manage multiple schemes,” says Nitin Agrawal, CEO, Mutual Fund, InCred Money.

 

The investor need not necessarily redeem his money when the target date arrives. “Auto-merger ensures your money stays invested in a structured manner instead of landing in your bank account, where it may be spent or reinvested poorly,” says Anand K Rathi, co-founder, MIRA Money.

 

Glide path not customised 

One limitation of these schemes is a single glide path for all customers in a fund. “There isn’t much room for customisation for investors with different incomes, risk tolerances, and financial circumstances,” says Rathi. He adds that a poorly designed glide path could also mean investors end up with a lower corpus.

 

Who should go for them 

Investors who do not choose appropriate products based on their time horizon will find these funds useful.

 

Many also fail to rebalance their portfolios as their target date approaches. “Investors who should glide into safer instruments closer to their goal but hesitate to do so due to tax or timing may find these funds useful,” says Vishal Dhawan, founder and chief executive officer (CEO), Plan Ahead Wealth Advisors.

 

Who should avoid them 

Some investors build a retirement corpus using a mix of equity, debt, and other asset classes. “This approach offers greater flexibility and customisation, but it requires disciplined investing over time,” says Gupta.

 

Investors who already do disciplined asset allocation themselves, or under advice, may not need an LC fund. “Investors who want flexibility on when they retire may prefer more flexible strategies than a fixed-tenure LC approach,” says Dhawan.

 

Selecting the right LC fund 

Investors should do “duration matching” while selecting a fund from this category. They have multiple goals such as their children’s education, their wedding, and their own retirement. “They can choose funds whose maturities match the timelines of each of these goals,” says Deepesh Raghaw, a Sebi-registered investment advisor.

 

The equity component would be higher in LC funds meant for long-term goals. “Investors should be comfortable with the interim volatility,” says Dhawan.

 

Investors should ensure that the glide path of their chosen fund aligns with their risk appetite.

 

Likely taxation 

These funds will be tax-efficient on one count. “Tax efficiency comes from rebalancing happening within the fund,” says Gupta.

 

The key question is whether they will get equity-like taxation at maturity. Greater clarity is needed from the regulator on this. “As the glide path reduces equity below 65 per cent, gains would be taxed at slab rate,” says Agrawal.

 

Sebi has allowed these funds to take exposure to equity arbitrage. “They could use arbitrage to avoid being treated as debt funds,” says Raghaw.

 

NPS LC funds remain relevant 

The National Pension System (NPS) also offers LC funds. “The MF LC funds may find it difficult to beat NPS on costs,” says Raghaw. He adds that LC funds from fund houses should also offer more granular asset-allocation tables, as NPS funds do.

 

What should investors in older retirement funds do? 

Investors who are in the older retirement and children’s funds should not panic. Raghaw suggests that investors wait for clarity on which funds they will be merged into, and then decide whether the new funds suit them. Remember that hastily selling and exiting these older funds will result in a tax incidence.

 

Dos and don’ts 

Investors should not invest in LC funds just because the category is new or because their net asset value will be ~10. They should instead focus on the alignment of these funds with their end objectives.

 

LC funds will not have a track record initially. As a proxy, Dhawan suggests considering the fund house’s track record in funds of a similar tenure.

 

Key features of LC funds

• A distinct mutual fund category that will have open-ended schemes with a target maturity date
• Multiple-asset investing allowed: equity, debt, InvITs, gold ETF, silver ETF, and exchange-traded commodity derivatives
• Mandatory glide path: Sebi-prescribed asset-allocation ranges across years to maturity
• Tenure: minimum five years, maximum 30 years
• Launch structure: tenures allowed in five-year multiples; up to six life-cycle funds per AMC
• Near-maturity treatment: when less than one year to maturity, fund may merge into the nearest-maturity LC fund, with unitholder consent
• Equity arbitrage: for years to maturity below five, equity arbitrage up to 50 per cent allowed, while keeping total equity and equity-related exposure within 65–75 per cent
• Exit load slab: 3 per cent if exited within first year; 2 per cent in second year; 1 per cent in third year