The ETFs industry in India is much younger than the mutual fund industry. These ETFs are barely a bit more than a decade old but are yet to take off in a big way in India. It’s difficult to choose over ETF vs FOF.
ETFs are created on certain benchmarks or certain assets. To give you an example, you can have an ETF on Gold or an ETF on Silver or you can have an ETF on any of the indices such as the Nifty or the Bank Nifty too. FOF (Fund of Funds), on the other hand, is a concept in which the FOF makes a portfolio of funds by mixing and matching funds to suit your investing needs.
Indian mutual funds connected globally have used the FOF route to make a portfolio of global funds of their foreign stakeholder to let Indian investors indirectly get access to global markets. But because global markets do not exactly make a lot of money, the focus on FOFs has been limited.
Since the last three decades, have been a lot of changes in the Indian investment landscape. While most of the investment options have specific advantages and disadvantages, understanding their characteristics is necessary to make an informed decision. Today, we will talk about two famous investment options – etf vs fof differentiate between them.
What is an ETF?
An ETF (Exchange-Traded Fund) is a basket of different securities like a mutual fund. The difference between mutual funds and ETFs is that an ETF can be traded on the stock exchange.
Investors prefer ETFs because they like these open-ended mutual funds that can be traded on the exchange throughout the day at an amount close to that of the underlying assets. This means that ETFs more liquid as compared to mutual funds. Generally, ETFs track an index – almost 85% of ETFs track an equity index.
What is FOF?
Just like a mutual fund invests in options like stocks, bonds, etc., a FOF (Fund of Funds) is a mutual fund that invests in other MF securities. These schemes can either be from the same fund house or different fund houses.
FOF is made to cater to the investment needs of people with different risk tolerances and investment goals. Fund of Funds can also be international.
6 Comparison points of ETF vs FOF
Let us take a look at the differences between etf vs fof :
An ETF is a basket of securities just like a mutual fund. They invest in securities like stocks, bonds, etc., and they generally track indexes.
A FOF is a basket of mutual funds. They invest in other mutual funds according to their investment needs and the risk they can take.
ETFs can be transferred anytime on a stock exchange just like a stock. So ETFs have higher liquidity than mutual funds. While the liquidity is based on the demand in the market, investors have to look for consistency in the volume of trading of an ETF before buying.
Because FOFs cannot be transferred like ETFs can be, the liquidity is much lower.
Because ETFs can be traded on a stock exchange, they are purchased or sold at the market price and not at the NAV. This is one of the biggest differences since all mutual fund schemes are bought or sold at their Net Asset Value (NAV).
The market prices of the ETFs are based on their demand and supply. Usually, an ETF with a high AUM (Assets Under Management) and heavy trading volume (daily) will not have a big difference between the market price and NAV.
FOFs are bought and sold at the NAV obtained at the end of the trading day.
If the cost is taken into consideration, then ETFs are much cheaper than FOFs. Generally, the expense ratio of an ETF is less than 0.5% because most of the ETFs are managed passively as they track an index. While FOFs are actively managed funds.
Hence, the cost of fund management is added to the expense ratio. Also, the funds that the FOF invest in might charge specific fees that are passed on to the investor as well.
The taxation system of TEF vs FOF
Thinking about taxation is an important part while choosing the right investment. Taxation of etf vs fof is discussed below:
According to the taxation point of view, there are three types of ETFs– equity, gold, and others. Here are the tax implications:
If you hold the ETF for less than one year, then the capital gains earned will be called short-term capital gains or STCG. The tax liability will be 15%.
If you hold the ETF for more than one year, then the capital gains earned will be called long-term capital gains or LTCG. LTCG up to 1 lakh rupees is exempt from tax. The tax liability of long-term capital gains over 1 lakh rupees will be 10% without indexation benefits.
Gold and Other ETFs
If you hold an ETF for less than three years, then the capital gains earned will be called short-term capital gains or STCG. The capital gains will be added to your yearly income and will be taxed according to your income tax slab rates.
If you hold an ETF for more than three years, then the capital gains earned will be called long-term capital gains or LTCG. These capital gains will have a tax liability of 20% with indexation benefits.
All FOFs are taxed as debt funds irrespective of the schemes they invest in. The meaning of this is that even if the FOF is investing in equity-oriented funds, the capital gains earned from investing in it will get the tax treatment of a debt fund. This is as follows:
If you hold the FOF for less than three years, then the capital gains that arise will be termed as short-term capital gains or STCG. These capital gains will be added to your yearly income and will be taxed according to the applicable income tax slab rates.
If you hold the ETF for more than three years, then the capital gains earned will be called long-term capital gains or LTCG. These capital gains will have a tax liability of 20% with indexation benefits.
How to Choose Between ETF vs FOF as an Investor?
If you are looking at investment options, there are some things that you must remember:
Returns on investments are proportional to risks directly. Therefore, if an investment has more risk, then it must provide a better opportunity to earn higher returns.
But while following this rule, make sure that you understand the investment avenue. While considering etf vs fof , go through the scheme documents and look at the asset allocation strategy and composition of the portfolio carefully.
Select the investment depending on your investor profile. There are three principles of an investor profile – financial aims, the tolerance to risks, and the time for which you want to stay invested.
If your investments are in sync with these three aspects, your portfolio will work well for you. For example, if an investor with a high tolerance for risk puts his money in an ETF that tracks the Nifty 50, then the returns will not be according to his expectations. This type of investor should take high-risk investments like mid-cap or small-cap funds, etc.
FOF’s provide a different option of diversification by investing in other mutual funds. Therefore, you can take the advantage of the experience and expertise of multiple fund managers. FOFs can be found in different versions like asset allocation funds, gold funds, international funds, ETF FOFs, etc. Make sure that you select the right one depending on what your investment portfolio needs.
Since ETFs can be traded on the stock exchange, they usually provide better returns over the long term. So they are a great alternative for stock investments but not for stock trading.
Both ETFs and FOFs are managed passively. Therefore, they are great for investors that are looking for investment avenues that are not managed actively.
Why you shouldn’t buy ETFs in India – The returns perspective
It is recorded that ETFs provide less than 1% of the total AUM of Indian mutual funds. There are 3 major causes for this.
Firstly, Indians know about discrete debt and equity products. They are not comfortable with an investment like ETF which is hard to understand as compared to a pure FD or a pure equity product. Lack of awareness is another cause of ETFs not being to take off in a big way.
India is a market for alpha too. Most investors do not like the idea of investing in equity just for the sake of earning benchmark returns. They think that SIPs in diversified equity funds a better option.
Just because the fund manager can use his discretion in an active fund, the performance is better through stock selection. Also, the Nifty has virtually been flat from March 2015 to March 2017. While an Index ETF would have given almost no returns at this time, diversified equity funds have clearly provided good returns.
Lastly, ETFs aren’t cost-effective like they are in the US and European markets. If you sum up the fund administration cost of an ETF and then add the market brokerage and STT and connected charges, there is not much of a cost-benefit in ETFs.
Why you should not buy ETFs in India – The taxation perspective
Another significant cause of ETFs in India not taking off is the taxation perspective.
On one hand in normal equities or equity mutual funds, the tax treatment is completely similar. If you hold them for a period of less than 1 year then it is short-term capital gains and if it is held for a period of more than 1 year it is considered as long-term capital gains. In both cases, long-term capital gains are free of tax and short-term capital gains are taxed at the concessional rate of 15%. That is one of the major cons of ETFs.
Firstly, an ETF profit will be classified as long-term capital gains only if you hold it for a period of more than 3 years.
Anytime below 3 years in the case of ETFs are considered as short-term capital gains. Secondly, the tax rate is not good too. While we think of ETFs in India, short-term capital gains are taxed at the peak rate of tax for the investor concerned while long-term capital gains are taxed at 10% without indexation or at 20% with indexation benefits.
Hence, ETFs in India score lower in terms of returns and also in terms of tax efficiency.
Then what about FOFs?
FOFs or Fund Of Funds is a very famous concept in the West and even across Asian economies.
Most institutions utilize the FOF concept for investing in mutual funds. In performance terms, these FOFs don’t show impressive results either.
Because a FOF that focuses on global markets does not exactly add value when the whole world is watching India for alpha. Secondly, tax treatment for FOFs is also not great.
Even if a FOF is the total of equity funds, it is still considered as a debt fund for tax purposes.
ETFs are passively managed funds, while FOFs are mutual funds created to cater to the needs of investors who want actively managed funds. Though as you can saw just now, there are various differences between the two. So it is necessary to understand these differences before making a decision. Visit our website WealthBucket to provide mutual fund services at a good cost. Our specialists will assist investors to receive benefits from numerous mutual fund schemes. Like equity fund investment, Debt mutual fund, Large Cap mutual fund, or Multi-Cap mutual fund. You can easily call on +91 8750005655 or just simply email at firstname.lastname@example.org.We to provide the best kind of services.