What is a multi-asset FoF?
A multi-asset FoF invests in underlying funds, usually from the same fund house, though that is not mandatory. It does not invest directly in securities. The portfolio may include equity funds, fixed income funds, exchange-traded funds (ETFs), and commodity ETFs.
“The FoF fund manager decides the asset allocation of the FoF. The respective scheme managers make investment decisions within the underlying schemes,” says Jiral Mehta, senior manager – research, FundsIndia.
A multi-asset allocation fund, by contrast, invests directly in securities such as stocks, bonds, and commodity ETFs. “These funds must invest in at least three asset classes, with a minimum allocation of 10 per cent to each,” says Mehta. These asset classes typically include equity, debt, and others such as gold or real estate investment trusts (REITs).
“In a multi-asset allocation fund, the fund manager actively manages both the asset allocation and the selection of securities within each asset class,” says Mehta.
Pros: In a multi-asset FoF, a single fund gives investors exposure to multiple asset classes through the underlying funds. Its main appeal is simplicity. “Investors seeking a hands-free, one-stop solution get access to a ready-made portfolio,” says Mehta.
A professional fund manager handles asset allocation decisions across equity, debt, and gold, and also manages rebalancing. Investors only need to invest and monitor performance.
FoFs also offer tax advantages. “Internal shifts across asset classes do not lead to capital gains tax for the investor,” says Rahul Jain, president and head, Nuvama Wealth.
Rebalancing across separate funds, by contrast, makes every redemption a taxable event. “For long-term investors, the compounding from saved taxes can be a genuine edge,” says Jain.
Cons: The fund manager decides the asset allocation in these schemes, and that allocation may not suit every investor. An investor may prefer a different portfolio mix.
Multi-asset FoFs are taxed at the investor’s slab rate for holdings under 24 months and at 12.5 per cent without indexation thereafter. “This is less favourable than the equity taxation an investor would get by holding an equity fund directly,” says Vaibhav Porwal, co-founder, Dezerv.
Within multi-asset FoFs, there are two variants: active and passive.
Multi-asset active FoF
In a multi-asset active FoF, the underlying schemes are actively managed funds, barring commodity ETFs. Investors in these schemes depend not only on the FoF manager to take the right asset allocation calls, but also on the managers of the underlying schemes to choose the right securities.
Pros: The FoF manager takes proactive allocation calls across asset classes and market capitalisation segments. On the fixed income side, the manager also decides the interest rate and credit positioning.
The underlying funds then make their own active calls. “An active manager can underweight an unattractive sector and overweight another sector that looks more attractive,” says Vishal Dhawan, founder and chief executive officer, Plan Ahead Wealth Advisors.
This flexibility becomes especially useful during market dislocations. “Active managers can shift to higher-quality debt, reduce exposure to a stock, or rotate within sectors to preserve capital,” says Porwal.
Such proactive fund management calls can generate alpha.
Cons: The broad and varied mandates of these active FoFs also create risks and uncertainties. “The investor may not know what kind of exposure the fund will take within equities, the market capitalisation segments the fund may take exposure to. The fund can also move into thematic funds. These decisions are taken by the fund manager and are not under the investor’s control,” says Kaustubh Belapurkar, director – manager research, Morningstar Investment Research India.
While active funds can generate alpha, they can also underperform their benchmarks. “If an underlying fund underperforms, the investor does not control how long that position is retained,” says Belapurkar.
Another risk arises from the expense ratio structure. The multi-asset FoF carries its own expense ratio while also bearing the expenses of the underlying active funds, which tend to be costlier than passive funds. “These funds can become expensive, especially if the multi-asset FoF itself is small,” says Belapurkar.
Multi-asset passive FoFs
A multi-asset passive FoF invests only in passive funds such as index funds or ETFs. These schemes do not invest in actively managed funds.
These funds usually follow a pre-decided asset allocation framework. Some multi-asset passive FoFs follow a rules-based, largely static allocation. The asset mix remains within tight bands, and the fund manager rebalances periodically. In others, the fund manager retains significant discretion regarding asset allocation.
The degree of rule-based structure vis-à-vis discretion varies across schemes. “It is the single most important thing to check before investing,” says Porwal.
Pros: Passive funds offer more predictable outcomes. These schemes do not carry fund manager selection risk. No fund manager bias creeps into stock selection and no concentrated bets can surprise on the downside.
In an active multi-asset fund of funds, the investor relies on the FoF manager to make the right asset allocation choices and identify active fund managers who will perform well. A passive FoF leaves asset allocation as the only source of excess return or underperformance.
Cost is another advantage vis-à-vis multi-asset active FoFs. “A passive FoF is subject to a regulatory cap of 1 per cent on total expense ratio. The underlying schemes are index funds and ETFs, which have lower fees,” says Porwal. He adds that over a 15- to 20-year holding period, this cost differential can compound into a meaningful difference in the final corpus created.
Cons: A passive fund invests in an index, and the index includes both strong and weak names. The fund manager cannot underweight or overweight sectors or stocks based on market views. A passive manager cannot cut exposure to a sector merely because it appears overpriced or because its outlook is negative.
This approach suits investors who believe markets are efficient. “It is for investors who believe asset allocation is the dominant driver of long-term outcomes and that alpha via security selection is hard to sustain net of fees,” says Porwal.
It also suits investors seeking a lower-cost and more rules-heavy allocation solution instead of manager discretion. New investors may also consider the multi-asset passive FoF option.
“It may be less suitable for investors seeking higher returns or alpha generation,” says Dhawan.
Multi-asset omni FoF option
An omni FoF can combine active and passive strategies within the same multi-asset structure. The manager can choose passive exposure where an index fund or ETF is more suitable and active exposure where active management offers an advantage.
“This gives fund managers the flexibility to use both active and passive funds at the underlying levels,” says Dhawan.
Do not begin the fund selection process by comparing returns. Focus first on the asset mix you want. Aggressive investors may want a higher equity allocation than conservative investors.
Understand the FoF manager’s asset allocation framework. Check how wide the asset allocation band is and how aggressively the manager uses the discretion available.
Also check whether the FoF manager can invest only in in-house schemes or can also buy schemes from other fund houses. “The investor may not get the best equity fund or the best debt fund in the country, but only the best that particular fund house can offer,” says Jain.
Dhawan adds that a structure that allows both in-house and external schemes gives the manager more choice.
