After stopping mutual funds (MFs) from accepting investments in their international schemes, the Securities and Exchange Board of India (SEBI) has loosened the strings.
However, this relaxation comes with a rider. International MF schemes will be allowed to reinvest in stocks of overseas-listed companies to the extent of the redemptions and consequent selling of such stocks from February 1, 2022.
Not all international schemes are able to use these new limits as international schemes had not seen much redemptions.
On the other hand, it has been business as usual for funds of funds (FoFs) investing in overseas-listed exchange-traded funds (ETFs). There is a separate $1-billion limit for these funds and according to industry sources, around $700 million-$800 million of this limit remains open.
While FoFs are also MF schemes, there are differences. Here is what you should know.
What kind of investments do they offer?
An FoF can invest in units of ETFs, index funds or even other MFs investing in securities listed overseas. Through such ETFs and other index funds, an FoF can offer investment ideas and themes that are not available in the domestic market. For example, Mirae MF has recently launched Mirae Asset Global X Artificial Intelligence ETF FoF and Mirae Asset Global Electric & Autonomous ETF FoF.
Both FoFs are investing in units of ETFs that are listed on overseas exchanges and give investors exposure to investment themes such as artificial intelligence, electric vehicles and driverless vehicle technology.
Through FoFs, you can also take exposure to US market indices, which is a more suitable avenue for your initial international exposure.
For example, Kotak NASDAQ 100 FoF and Aditya Birla Sun Life NASDAQ 100 FoF invest in iShares NASDAQ 100 UCITS ETF. The NASDAQ 100 is an index of the 100 largest US companies listed on the Nasdaq stock exchange.
For someone looking at much broader US market exposure, the Sachin Bansal-backed Navi Mutual Fund recently launched US Total Stock Market FoF, which invests in an ETF run by Vanguard, the US asset management firm that is the pioneer of passive investing.
The Vanguard Total Stock Market Index Fund ETF (VTI ETF) tracks the CRSP US Total Market Index, a broad US index that covers nearly all of the US equity market across multiple sectors, and comprises more than 4,000 stocks.
Fees
According to the regulations laid down by SEBI, FoFs can charge up to double the total expense ratio (TER) of the underlying ETF, subject to a maximum limit of 1 percent.
For example, if the TER of the ETF is 40 basis points (bps), the FoF can charge 80 bps.
But if the TER of the ETF is 60 bps, the FoF cannot charge 120 bps as the maximum limit of 1 percent will apply.
Taxation
Like all international schemes, an FoF is treated like a debt investment for taxation purposes.
This means that to get preferential long-term capital gains tax (LTCG) rate of 20 percent and indexation benefit, you would need to hold the investments for at least three years.
If you have capital gains and you withdraw your investments before three years, your gains will be treated as short-term capital gains and your income tax slab rates will apply.
Do you need a demat account?
While a demat account is a must for buying an ETF on domestic exchanges, you don’t need one when buying these ETFs through the FoFs.
This is because FoF is structured as an open-ended mutual fund scheme that is pooling all investors’ money and then deploying it in the ETF or combination of ETFs on your behalf. So complying with KYC or know your customer requirements are enough to start investing in an FoF.
How much to invest in these FoFs?
Allocate money in line with your asset allocation, decided on the basis of your financial goals. Do not chase a theme just because it is in the news. If you are a beginner, stick to large-cap exposure of developed markets like the US. Invest through systematic investment plans and gradually build your exposure up to 10-20 percent of the desired equity exposure of your portfolio.