Mutual funds’ search for debt fund alternatives reaches FoF space
Source: Business Standard
Mutual funds’ search for debt fund alternatives has now reached the fund of fund (FoF) space. At least two fund houses — HDFC and Aditya Birla Sun Life (ABSL) — have sought the regulator’s go-ahead to launch FoFs that can offer debt fund-like returns but with better tax efficiency.
Fund houses have been exploring new low-risk product possibilities since the change in taxation in April 2023 spelled doom for debt funds. Some fund houses like Edelweiss and PPFAS took the hybrid fund route to fill the gap by creating tax-efficient, lower-risk products.
The change in the tax structure of FoFs in the latest Budget has opened room for more possibilities.
The two proposed products, HDFC Debt Advantage FoF and ABSL Income Optimiser FoF, will invest over 35 per cent of their corpus each in arbitrage funds and debt-oriented schemes. These schemes plan to cap the maximum allocation to the two scheme categories at 65 per cent, as per the draft filed with the Securities and Exchange Board of India (Sebi).
FoFs invest in one or multiple mutual fund schemes rather than buying securities directly. As per new tax rules, FoFs investing less than 65 per cent in debt funds will qualify for long-term capital gains tax benefit; the gains will be taxed at 12.5 per cent if the investor stays invested for more than two years.
“Such offerings can find a place in investor portfolios, given the tax advantage. However, much will depend on the debt funds they invest in and how well these funds are managed. In addition, the expense ratio should be reasonable for the fund to be able to compete with other lower-risk investment options,” said Rushabh Desai, founder, Rupee With Rushabh.
Expense ratios of FoFs are generally higher as investors have to pay expenses for both — the FoF and its underlying funds.
Since the change in debt fund taxation, arbitrage funds have emerged as the preferred debt fund alternative. In the last year, these schemes have raked in over Rs 1 trillion, largely driven by their strong performance and equity taxation.
Experts say that the proposed FoFs can compete with arbitrage funds, provided they are managed well.
“Given the mix of arbitrage and debt allocation, the predictability of returns can be higher in the case of these FoFs compared to pure arbitrage funds. The FoFs will have an added advantage if the fund manager has ample flexibility to shift between various debt funds to make the best out of the prevailing market conditions,” said Rahul Jain, senior vice-president research, International Money Matters.
First Published: Sep 26 2024 | 3:52 PM IST
