Playing safe

Fund of funds is nothing more than an asset-allocation plan

The fund of funds (FoF) concept may be new in the Indian markets, but it has been around for years in the American and European markets. An FoF is essentially a mutual fund that invests in other mutual funds.

The rationale: it may be far too difficult for lay-investors to choose the best performing fund from the plethora of schemes in the market-place.

So an FoF with a portfolio of probable winners managed by a professional manager could reduce risk and increase the chances of delivering superior returns.

Besides, FoF managers will undertake a systematic portfolio re-balancing to phase out non-performing funds from time to time.

The Indian version of FoFs is, however, not quite the same. Indian FoFs, managed by domestic mutual fund houses, are offering to invest in a portfolio of schemes under their banner.

So a Prudential ICICI FoF would invest in a chosen set of schemes managed by Prudential ICICI Mutual Fund, a Franklin Templeton FoF would invest in an assortment of schemes managed by its own fund managers and so on. What is the logic? Fund houses feel that they have the necessary diversity in their own portfolio to suit their investors' needs.

Players and products
As of now Prudential-ICICI AMC and Franklin Templeton have launched their FoF products. Birla Sun Life (BSL) has got clearance from Sebi for its FoF and HDFC AMC is likely to come out with a similar product within the next two months.

Prudential ICICI's PruICICI Advisor Series offer five different plans and have growth, dividend payout and dividend reinvestment options under them.

All the plans have a minimum investment of Rs 5,000, and the minimum additional investment is Rs 500 and multiples thereof. The plans have entry loads ranging from zero for the PruICICI Very Cautious Plan to 1.5 per cent for the PruICICI Aggressive Plan.

Templeton has also launched its FoF scheme and has two plans lined up for its investors. There is a Life Stage Scheme and a Dynamic P/E Ratio Fund. The former is a combination of different plans keeping in mind the risk appetite of various age groups which are broadly 20-30 years, 30-40 years and 40-50 years and so on with different mixtures of equity and debt.

However, a young at heart 50-year old is welcome to invest in the aggressive plan for the younger age groups to whet his risk appetite. The Dynamic P/E Ratio Fund benchmarks itself with a particular index like the Nifty 50.

BSL is planning to launch the products within a month. According to Jayashankar Madhavan, head of portfolio risk management at BSL, the company's FoF would have three plans - conservative, moderate and aggressive.

Madhavan says the target group for its FoF would be aggressive investors - in the age bracket of 25-40 years - who can withstand two business cycles.

So, is the FoF just a glorified asset allocation plan? Yes. It is an asset allocation plan with a dash of dynamism. An asset allocation plan has pre-defined allocations of equity and debt. An FoF, on the other hand, has the flexibility to change its asset allocation within a specified band.

"The fund manager of an FoF scheme can take advantage of the economic scenario for optimum debt-equity allocation, which brings in an element of dynamism in FoFs - the main differentiator which is lacking in an asset allocation plan," says a vice president of a prominent AMC.

A fee for laziness or discipline?
An FoF is essentially for the lazy investor. Nimish Shah, chief executive, Parag Parikh Financial Advisory Services, puts it differently, "Buying an FoF is an exercise in not taking part in the management of the fund. Investors do not take the time or effort to do research on the stocks or funds that they are investing in."

Lazy investing always comes at a cost. In FoF, it comes in the form of additional investment management fee. Mutual funds are allowed to charge upto 0.75 per cent as asset management fee for managing a FoF scheme.

This obviously is on top of the asset management fee charged by the AMC for various fund schemes in which the FoF invests. So fund managers simply charge for rebalancing fund portfolios periodically.

What if you do it on your own? If one invests in funds directly, rebalancing cost may work out to be higher at times. Every time an investor gets in and out of a fund scheme, he is charged an entry and exit load. Frequent rebalancing may mean higher costs in the form of loads.

Says Hemant Rustagi, who has started his mutual fund distribution company after resigning from ING Mutual as its chief marketing officer, "One positive aspect is the tax benefits and cost savings that an investor could make in case of portfolio rebalancing. If investors do the rebalancing under normal mutual fund schemes, they would be paying costs and capital gains tax. In case of the funds being under the same family, an FoF scheme would offer the twin benefits of automatic portfolio rebalancing done by experts and with zero tax liabilities in the sense that the result of the portfolio rebalancing would not have the customer exit the scheme."

There is also a positive way of looking at this. An FoF does bring in an element of discipline in investing which even many seasoned investors may lack. Since FoF schemes have to maintain their asset allocations within the defined limits, they don't run the risk of getting carried away in overheated markets.

Rustagi says ultimately it is the discipline of systematic asset allocation that is the main allure for FoFs. FoF schemes would entail ideal asset allocation in various market conditions, increasing the equity component when stock markets are looking good and decreasing it to the minimum when the markets look overheated.

One could also take solace from the fact that there are not many investors possessing the knowledge or discipline to stick to an asset allocation plan.

So, for a new investor who has a limited knowledge of the financial markets and still wants more returns, FoFs offer the best alternative.

For a slightly higher cost, he can avail the benefit of having experts manage his portfolio according to his risk profile and have the satisfaction of following the discipline of systematic asset allocation.

You can choose an asset allocation and stick to it, with no need of constantly monitoring your investments, saving time and nerves.

The broad asset allocations that are currently available should also suit most people. The choice of a fund house is also simpler than choosing a mutual fund scheme which need a lot of expertise.