From active allocation to passive funds, here’s how to combine multiple assets into a single fund


Wealth management is an investment advisory service that combines other financial services to meet the needs of wealthy clients. A wealth management advisor is a high-level professional who manages the wealth of a wealthy client in a comprehensive and profitable manner. However, the wealth management process has two parts: The wealth manager works on the allocation to asset classes (equities, debt, gold), and to specific funds (including large caps, small caps, debt funds) .

The fund manager manages the allocation to specific securities in accordance with the fund’s mandate – eg large cap, small cap, short duration, etc. – and modulates the fund’s portfolio according to its reading of the underlying market.

Passive fund management

A trend in this process of allocation to portfolio instruments is that of passive fund management. There is a benchmark index for each fund, which is the relevant index. In a typical fund, called an actively managed fund, the objective of the fund manager is to provide returns above those of the index. However, it remains to be seen whether this objective will be achieved.

In a passive fund, the objective is to simply replicate the underlying benchmark index, without any pretense of outperformance. The fees charged to a passively managed fund are lower than actively managed ones, and the investor is happy with that.

Multiple allocation in a fund: how does it work?

What if the two aspects of allocation, i.e. assets and particular securities, were combined in a single fund? It’s a new idea on the horizon. Let’s first look at how multi-allocation is currently done in a fund. There is a fund category called Multi Asset Allocation, which according to SEBI fund categorization rules is defined as “Invests in at least three asset classes with a minimum allocation of at least 10% each across the three classes of assets”.

Typically, asset management companies have more than 65% equity in multi-asset funds because investors prefer equity taxation and equity is the growth asset; 10% or a little more in gold, and the balance in debt securities. It is therefore an active management of the allocation to specific categories and instruments.

The new idea is that there is a new fund offering (NFO) from ICICI Prudential AMC. In this fund, called Passive Multi-Asset Fund of Funds, the manager plays the role of wealth manager, deciding on the allocation to the three asset classes. The allocation ranges are domestic equities 25-65%, debt 25-65%, gold 0-15% and global equities 10-30%. Within the broad ranges, the fund manager will decide the allocation based on the underlying market situation and outlook.

Let’s understand this from an example: when stock market valuations are attractive, the allocation will be towards the top of the range (65%) and when the market is hot, it will be towards the bottom (25%). This will be done on the basis of an internal parameter-based model which includes interest rates, inflation, fiscal deficit, current account deficit, capital expenditure in the economy, index of purchasing managers (PMI), global outlook, etc. allocation to asset classes, exposure is taken through passive funds. Passive funds can be from the same AMC, i.e. ICICI Prudential or any other AMC, to improve efficiency.

The tax aspect of this new idea is relevant for investors. If this is done through direct instruments such as stocks or bonds, and an adjustment is needed in the relative allocation, there are tax implications on the recognition of the gains. If this is done through the usual equity or debt funds, there is also a tax implication. However, when a mutual fund sells a portfolio security, the gains are not taxed because mutual funds are tax-exempt trusts. The tax we pay on our MF investments is a tax on us, on the gains from the units we hold in the fund. Therefore, when a multi-asset fund changes portfolio allocation, it is a tax-efficient decision for the investor.

Fund of funds

The other aspect is that since the new idea is a fund of funds and not the usual multi-asset fund, the taxation is that of debt funds, even if the allocation to equity funds is more than 65%. Apparently, it’s not as tax efficient as equity. However, there is a nuance here. You must have a three-year horizon because the investment is intended for the generation of wealth over several years. Over a holding period of three years, debt funds benefit from indexation for the taxation of capital gains.

The data shows that since the start of the current series of cost inflation indices, 2001-02, the effective tax rate on earnings has averaged less than 10%. The capital gains tax rate on shares over a one-year holding period is 10 percent.

Net-net, if you want your fund manager to get rid of the subjectivity of instrument selection and make a broad allocation to asset classes based on the market situation, you can opt for this fund.

(Writer is a corporate trainer and author)

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Posted: Sunday, April 10, 2022, 12:54 PM IST

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