The Hindu Business Line : Fund of funds for efficient asset allocation

EVERYBODY has changing investment requirements, depending on the market conditions and personal needs. Most people tend to invest more in equity despite market frenzy. People kept buying when the Sensex was riding 6000-plus and are ruing their decision as there has been an average 25 per cent loss in the corpus, with the market dropping thereafter. Surprisingly, this mistake is committed by even the so-called financial savvy professionals. Likewise, it was common in 2002 for investors to go overweight in debt with unnaturally high returns from fixed-income investments. Investment in property happened mostly at the boom time (the early 1990s).

Moral of the story: Investors invariably do not make proper asset allocation.

Asset allocation is crucial because the markets are volatile. The risk aptitude of an investor depends on his age. Who does not want high returns? For instance, a 56-year-old early retiree will not be willing to risk his principal, buta young professional may take a chance as he has better wherewithal, in the shape of a long career tenure, to take losses.

Gone are the days, when investment planning was done once a year. These days people make changes in asset allocation rather frequently.

It also emerges that while a large population of investors is happy investing in mutual funds, the entry load acts as spoilsport. One possible solution to the above issues could be the development of a grand fund called "fund of funds" (FoF). The FoF can be equated to mater funds which can have an investor's total corpus of mutual fund investments. That is, if an investor has scattered investments in four-five funds and 10-15 direct scrips, he can instead invest his full amount in an FoF. The FoF will give the investor the option of allocating his investment, say, in an aggressive (75 per cent equity and 25 per cent debt), moderate (51 per cent equity and 49 per cent debt), conservative (25 per cent equity and 75 per cent debt) or dynamic debt (0 per cent equity and 100 per cent debt) plans. This allocation can be done on the basis of a detailed risk profiling done by an investment advisor or the investor himself.

Internationally, the FoF is very popular, as it has the investment expertise and disciplined approach of the fund manager. More than this, the FoF is economical as the entry/exit load is avoided. The FoF will also have the advantage of cashing in on equity market surges and will dynamically review rebalancing strategies so as to take advantage of the rising market. A study done for funds without rebalancing during the volatile period of April 1998 to October 2003 revealed that without balancing equity exposure grew to 84 per cent. The product feature provides a disciplined approach to investment and the investor is insulated from taking decisions based on the market sentiments.

The FoF is also tax efficient. Presuming that an investor has shown the agility to cash his pure equity fund (to take advantage of growing equity market) and invest in a debt fund, he will be burdened with a short-term capital gain tax (33 per cent). If in another two months he again switches from one scheme to another, another dose of short-term gain tax would be payable. Whereas if he invests in an FoF, such short-term taxes will not be levied as such transactions are not done by the individual. Though the FoF is a new entrant to the Indian market,many variants are likely to be available from different fund houses. The FoF has a promising future in India, as it tries to address some of the practical concerns of investors. It will not be surprising if people use the FoF as an alternative to the portfolio management scheme (PMS) run by many brokerage houses where the minimum investment needed is Rs 50 lakh.

(The author is Chief Operating Officer, Birla Global Finance Ltd., Mumbai. The views are personal.)

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