broad diversification and asset allocation, along with tax benefits.
Fund of funds are generally suited for smaller investors that seek access to a range of different asset classes, and a geographic diversification.
However, the recent tax amendments on debt funds by the government is likely to have negative implications for this fund category, believe experts.
According to the new rules that come into effect from April 1, mutual funds with less than 35% investment in equities will be taxed short-term capital gains (STCG) based on income tax slab levels, similar to how bank fixed deposits are taxed.
The tax amendments by the government is not only applicable to debt mutual funds but also other non-Indian equity categories like international funds, fund of funds, gold and silver ETFs/index funds, and debt hybrid, said Alekh Yadav, head of investment products, Sanctum Wealth.
“All these funds will now be taxed at the marginal tax rate of a client no matter the holding period. This shall reduce the post tax returns on these investment options,” Yadav said. There are around 49 Fund of Funds investing in overseas assets with an average net AUM of Rs 22,465 crore.
Indians have a significant investment overseas through mutual funds, and therefore, the
change in the tax structure makes international equity funds unattractive, said Santosh
Navlani, COO, ET Money.
Elaborating with an example, Navlani said if an investor makes 12% from Indian and international funds, including the currency depreciation. If he/she falls in the 30% tax
bracket, the post-tax returns would be around 8.4% for investing overseas.
On the contrary, on Indian equity investments, the returns would be about 10.8%.
“Ideally, one should invest in international funds for geographic diversification. But the reality is that investors chase returns. If returns are impacted due to taxation or any other reason, investors don’t find such investments attractive,” Navlani added.
For mutual funds to attract investment in their Fund of Funds and International Funds categories, the products will have to become competitive on the cost front, experts said.
“Currently some of these international feeder funds are quite expensive. Since investors’ post tax returns will decline, these mutual funds need to be more competitive on their expenses,” Yadav said.
Some funds may also consider mixing Indian equities with international equities to push the fund into the equity mutual fund category from a taxation perspective, he said.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)