Tax change, spike in inflows revive interest in Rs 84,000-crore FoF space

The Rs 84,000 crore domestic fund of funds (FoFs) space, which was in the doldrums over the past 18 months, has now caught the attention of investors due to a change in the tax structure in Budget 2024.

The broader category, which includes offerings across equity, debt and commodities, has seen a spike in the inflows over the past two months.

FoFs typically deploy the pooled capital in one or multiple MF schemes rather than investing directly into equities, debt or commodities.

Currently, there are 84 domestic FoFs, with a majority of them being feeder funds of exchange-traded funds (ETFs). These FoFs invest in their respective ETFs.

However, the space also allows fund houses to offer differentiated offerings like asset allocation or multi-sector products.

In July, these schemes collected Rs 478 crore, followed by Rs 1,007 crore in August.

Last month’s inflows were the highest since March 2023.

During the 15-month period from April 2023 to June 2024, the category saw aggregate outflows of Rs 2,243 crore.

Experts say that with the rekindling of investor interest, fund houses may once again start to create differentiated products through the FoF route.

Madhu Nair, chief executive officer at Union Asset Management Company (AMC), said the AMC is exploring products in this segment.

“Earlier, FoFs were not attractive at the hands of investors.

"With the alignment of FOFs tax structure to two years for long-term capital gains at 12.5 per cent, it may be a strong proposition for long-term investors.

"We are evaluating at launching solution oriented FOFs schemes which may be suitable for investors with different risk profiles and time horizon,” he said.

At least one fund house — Aditya Birla Sun Life MF — has sought the regulator's approval for a first-of-its-kind offering using the FoF structure.

The asset manager has filed papers for a yield enhancer FoF, which will invest across arbitrage funds, debt funds, gold and silver ETFs, REITS & InvITs and money market instruments.

Prior to the tax change in March 2023, most of the multi-asset funds were FoFs, which invested in schemes and ETFs across asset classes.

There are pure equity FoFs that invest in multiple schemes.

Chintan Haria, principal investment strategy at ICICI Prudential MF, said the advantage of FoFs is that it provides investors a diversified exposure through a single product.

"The primary goal is to tap into the fund house expertise to provide diversification and access to a variety of asset classes, fund managers, and strategies within a single investment.

"By investing in FoFs, investors can spread their risk across different funds and managers, potentially improving returns while reducing volatility," he said.

The slump in the inflows into FoFs from April 2023 was due to the change in taxation.

In Budget 2023, the government removed the long-term capital gains (LTCG) tax benefits for non-equity funds.

Gains from all non-equity schemes, including FoFs, started getting taxed at the investor's slab rate.

In the latest Budget, FoFs along with commodity and international funds regained the LTCG advantage.

Gains from such schemes from FY2027 will be taxed at 12.5 per cent if the investor has stayed invested for more than two years.