What are feeder funds?

Here is my article on the subject "What are feeder funds?", published in Mid-day Gujarati edition.

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The English translation is as under:

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In some of our earlier articles, we have talked about gold mutual funds. These come in two varieties – Gold ETFs and Gold Savings Fund. While the former invests in gold, the latter invests in the units of a Gold ETF. Such an arrangement makes it a feeder fund.

A feeder fund is a type of mutual fund that invests in the units of another mutual fund scheme. Unlike a fund of funds, which invests in multiple schemes, a feeder fund invests in only one scheme.

One may wonder:

·      Why should a mutual fund scheme invest into another?

·      Why can’t one launch a new scheme?

The questions are valid and still we have a few feeder funds.

So let us start with what kind of feeder funds we have in India. We have already referred to one category: Gold savings funds that invest in units of Gold ETFs. The second category of funds invests in units of another international mutual fund. An international mutual fund may be investing in various assets outside of India.

First of all, when SEBI allowed mutual funds to buy gold, it was only under the ETF structure. However, as the limitations of ETFs surfaced, the chief among those being that one could not do systematic investing in an ETF, need was felt for an open-ended fund that allowed investment in gold. Instead of going to SEBI for change in regulations, the mutual fund companies found out that even within the existing regulations, it was possible to create a feeder fund structure and that is how gold savings funds came into existence.

The other structure – funds feeding into international mutual funds – was a result of costs involved in managing schemes investing in international markets while being in India and of small size. The costs involved may become prohibitively high and all the potential gains through active management may vanish. So funds innovated and came out with feeder funds feeding into some of the global biggies’ funds – most often, their parent company’s schemes.

Thus, feeder funds came due to one of two reasons: (1) limitations imposed by regulations, or (2) economic viability

In both the cases a feeder fund was the most appropriate option.

- Amit Trivedi, Author of "Riding The Roller Coaster - Lessons from financial market cycles we repeatedly forget"

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Buying gold is more convenient now

My article in Mid-day Gujarati's Mumbai edition today:

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The English translation is as under:

The festival days are here. This is the season of buying Gold in many Indian families. Buying gold for investment purposes was highly inconvenient at some point in time, as the laws did not allow one to buy gold in any for other than jewelry. Today, it has become very convenient to invest in gold.

Buying physical gold has its own limitations.

Most of us cannot make out the difference between 18 carat gold and 24 carat gold. The price difference could be very high between the two. We can buy certified gold, as that facility is available now. However, this facility comes with a price. Any additional price paid reduces the future returns from the investment.

Physical gold also needs to be stored properly, as the precious metal suffers from the risk of theft.

Physical gold has to be added to one’s wealth for the purpose of calculating wealth tax. Thus, if the total wealth exceeds the minimum cut-off limit, one would be required to pay wealth tax irrespective of whether one is earning on the same or not. A tax outflow is an expense and it brings down the return on investment.

A recent innovation has taken care of the above limitations. (Although, this is a decade old innovation, many do not know about it). This innovation is known as Gold ETF – a mutual fund scheme that allows one to participate in the growth of price of gold. It is a financial instrument through which one can reap the benefit of investing in gold.

Gold ETFs are mutual fund schemes that invest in physical gold and issue units against these to the scheme’s unitholders. The gold is stored with a SEBI registered custodian. Periodic audits are carried out to ensure that for each unit of Gold ETF, there is an equivalent quantity of gold available with the custodian. The NAV of the unit varies in line with the price of gold in wholesale commodities market. The unit of a mutual fund is defined as “security” and hence is exempt from wealth tax. Since the gold is stored with a custodian and the investor only holds demat units, the risk of theft is eliminated.

These units can be bought through the stock exchanges with the help of member brokers. One needs to have a demat account for this purpose as the units purchased through stock exchanges are delivered only in demat format.

The mutual fund companies innovated further and introduced another category of mutual fund schemes that allows an investor to hold the units through an account statement without the need for a demat account. These are popularly known as gold savings funds.

Take advantage of these innovations to accumulate units of gold.

With you all a very Happy Diwali and a Prosperous New Year!

Note: This article is not about whether gold is a good or a bad investment. It is about a new and convenient way of investing in gold. At the same time, it is important for one to understand why one is buying gold.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.