Whar are Feeder Mutual Funds or Fund of Funds?

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Feeder Mutual Funds

To an average Indian investor, global investing is a relatively unexplored territory and would definitely seem like a road less traveled. However, such global funds do exist for Indian investors and are either geographically specific or thematic in nature. They invest into a specific market, such as the US, China or Brazil, or into a region, such as Asia ex-Japan or the emerging markets. The themebased ones focus on gold mining, energy or agri-business.

Despite being around for a number of years, global funds have only recently picked up in terms of sheer number available. As per AMFI data, in early 2008 there were around six global feeder funds available in India. By October 2013 that number swelled to 23. This is only poised to increase as a number of fund companies have filed offer documents with Sebi to launch such funds.

The total assets managed by these funds stood at around Rs 2,400 crore (less than 1% of Indian fund industry’s assets) at the end of October 2013, as per AMFI data. Compare this with the world’s largest mutual fund market, the US. As per the ICI Factbook 2013, domestic equity funds constitute around 33% of total US fund industry assets, while international equity funds account for 12% of industry assets.

Reserve bank of India increased the overseas investment limit for mutual funds in India to $7 billion in April 2008 (from $5 billion at the end of 2007), with an individual fund house limit of $300 million. However, till date the total assets managed by such funds in India is nowhere close to the overall limit.

Benefits and Limitations

The most obvious benefit of global feeder funds is geographical diversification. Indian investors tend to question the logic of investing in global funds when the Indian market is doing well. It is this mindset that results in such funds gaining traction when the Indian market is underperforming its global peers, as has been the case in 2013.

It is worth remembering that all markets go through periodic cycles. There is no certainty that a particular market performing well presently will continue to outperform every year on a regular basis. This year itself, India has under perfor med a number of developed markets by a significant margin. Also, during the market downturn of 2008 and 2011, the Indian market was a relative underperformer when compared to a number of other international markets. An allocation to global funds in a portfolio would have helped to diversify risk.

A huge disadvantage of such funds is the unfavourable capital gains tax treatment, as compared to domestic equity funds. Funds investing primarily in foreign securities (even equities) and Fund of Funds (FoF) schemes are not considered as equityoriented funds by the taxmen in India. Thus they lose out on the beneficial capital gains tax treatment of equity-oriented funds, which are presently subject to a short term capital gains tax of 15% (plus surcharge and cess) while long term capital gains is exempt from taxation. However, for other funds (which are not equity-oriented), short-term capital gains are taxed at the applicable income tax rate, and long term capital gains are subject to a tax of 10% (without indexation) or 20% (with indexation).

Global funds also carry currency risk. Appreciation in the rupee will drag down returns for global feeder fund investors, while depreciation in the Indian currency against the dollar (in which the underlying parent fund is denominated), helps to boost returns. We have seen the latter scenario play out in 2013, when just a few months ago the rupee fell to historically low levels.

It’s difficult for an individual investor to time currency moves, as it can go either way. Therefore, the main premise of investing into global funds should be to diversify one’s portfolio geographically, not to make a currency gain. This helps lower the risk of a portfolio too.

As the Indian market matures and opens up, global funds are likely to find wider acceptance amongst portfolios of Indian investors. However, these funds may not be suited for first-time or novice mutual fund investors. The idea should be to first build up a domestic portfolio, and then diversify it using the medium of global funds

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