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"

Chat transcript - 14th Dec, 2015

Below please find link to the transcript of my chat session on www.moneycontrol.com on 14th Dec, 2015

Equity investments simplified

Benefits of investing in International mutual funds

How do international mutual funds work? Are there reasons why someone should consider these funds? For details, read the article in Mid-day Gujarati ...

Benefits of investing in international mutual funds

The English translation is as under:
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Many parents aspire for foreign education for their kids. This is evident from the number of column centimeters that the education consultants’ advertisements occupy in the newspapers. In such a case, it would be worth considering the cost of such education for the parents of a young kid in high school.

Some time ago, one of the newspaper reports talked about the rise in education costs in the US. The report suggested that between 1985 and 2013, the college fees went up 6 times. This is an annual growth of 6.6%. Considering the inflation in India, this rate of price rise looks small.

However, an Indian parent planning to send the child abroad, must also add the change in the exchange rate between US Dollar and Indian Rupee (Assuming that one is considering sending the child to the US).

On December 1985, the exchange rate was Rs. 12 to a Dollar (Source: Reserve Bank of India). The same was Rs. 65 to a Dollar in 2013. Hence, the cost of education went up 6 times in Dollar terms, and almost 400 times in Rupee terms. This works out to price rise @ 13.25% p.a. over this entire period.

Any major expense in the future must be adjusted for the expected rise in price, if one wants to properly plan.

One of the ways to protect one’s investments against inflation is to invest in assets that have the potential to beat it, viz., equity. However, in the discussion so far, one of the components of this inflation is the change in the exchange rate. In such a case, it might be a good idea to invest in foreign equity funds. If a parent is planning to send the child abroad for higher studies – say ten years from now, one may consider investing in international equity mutual funds. These funds offer protection against potential depreciation in the Indian currency.

Does this mean we are expecting the Indian Rupee to go down against the world currencies? No, we do not know whether Rupee would appreciate or depreciate. It is exactly in such a situation when one is not sure that protection is required.

Today, we have a large number of mutual fund schemes available in the Indian markets that invest in equity markets across various sections of the world market.

Apart from the benefit we highlighted above, these schemes also offer the benefit of diversification to the Indian investors. Even if one does not have a goal to spend money abroad, diversification is a reason enough to consider these funds. If we look at a typical India investor’s portfolio, in most cases, the entire investment is in India – be it stocks, mutual funds, debentures, fixed deposits, post office savings schemes, PPF, real estate – everything is in India.

Although, people are expecting India growth story to continue, one is not sure if the growth path would be smooth or bumpy.

What are the options available today?

Indian investors have two options to invest abroad:

1.     Under the Reserve bank’s liberalized remittance scheme, a certain sum of money can be invested by each income tax assesse every year. However, this process is complicated and hence must be left to those who have substantial sum of money.

2.     Indian mutual funds are allowed to launch schemes that invest in securities abroad. We have today many international equity funds offering exposure to various markets, e.g. US, Europe, Brazil, China (both directly as well as through Hong Kong), emerging markets, Asian equity markets, etc.

There are two types of funds – those that buy securities directly and those that simply buy an existing mutual fund investing in such securities.

All these funds are classified as non-equity funds for the purpose of taxation and hence they are subject to dividend distribution tax, if you opt for dividends and on capital gains tax on redemption.

Consider this as a new alternative and hence tread cautiously. At the same time, it may not be wise to ignore these funds.

Amit Trivedi

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

Disclaimer: This article should not be construed as investment advice.

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