Better wealth management: From active allocation to passive funds, here's how to bring multiple assets in one fund

Joydeep Sen | Updated on: Sunday, April 10, 2022, 12:54 PM IST


Wealth management is an investment advisory service that combines other financial services to address the needs of wealthy clients. A wealth management advisor is a high-level professional who manages an affluent client's wealth holistically, at a fee. However, the wealth management process has two sections: The wealth manager works on the allocation to asset categories (equity, debt, gold), and the specific funds (particular large cap, small cap, debt funds).

The fund manager manages the allocation to specific securities as per the mandate of the fund — example, large cap, small cap, short duration, etc. — and modulates the fund portfolio according to his/her reading of the underlying market.

Passive fund management

A trend in this process of allocation to instruments in the portfolio is that of passive fund management. There is a benchmark for every fund, which is the relevant index. In a usual fund, called actively managed fund, the objective of the fund manager is to deliver returns better than the index. However, whether that objective would be achieved is a question.

In a passive fund, the objective is to just replicate the underlying benchmark, without any pretensions of outperformance. The expenses charged to a passively managed fund is lower than actively managed, and the investor is happy to that extent.

Multiple allocation in one fund: How it is done?

What if both the aspects of allocation, that is, assets and particular securities, be combined in one fund? That is a new idea on the horizon. Let us first see how currently multiple allocation is done in one fund. There is a fund category called Multi Asset Allocation, which as per SEBI fund categorisation rules is defined as “Invests in at least three asset classes with a minimum allocation of at least 10 percent each in all three asset classes.”

Usually, AMCs have more than 65 percent in equity in Multi Asset Funds as investors prefer equity taxation and equity is the growth asset; 10 per cent or little higher in gold, and the balance in debt instruments. Hence, it is an active management of the allocation to categories and specific instruments.

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

Let’s understand this from an example: When the equity market valuations are attractive, allocation will be towards the higher end of the band (65 per cent) and when the market is heated, it will be towards the lower end (25 per cent). It will be done on the basis of in-house parameter-based model that includes interest rates, inflation, fiscal deficit, current account deficit, capital expenditure in the economy, purchase managers index (PMI), global outlook, etc. Having decided the allocation to the asset classes, exposure is taken through passive funds. The passive funds may of the same AMC, that is, ICICI Prudential or of any other AMC, to enhance the efficiency.

The taxation aspect of this new idea is relevant for investors. If it is done through direct instruments like equity stocks or bonds, and an adjustment is required in the relative allocation, there are tax implications on booking of gains. If it is done through the usual equity or debt funds, then also there is a tax implication. However, when a mutual fund sells a security in the portfolio, there is no taxation on the gains as MFs are tax-free trusts. The tax we pay on our MF investments is a tax on us, on the gains in the units we are holding in the fund. Hence when a Multi Asset Fund does the tweaking in allocation in the portfolio, it is a tax-efficient move for the investor.

Fund of Funds

The other aspect is that the new idea being 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 per cent. Apparently, this is not as tax efficient as equity. However, there is a nuance here. You need to have a horizon of three years as the investment is for multi-year wealth generation. Over a holding period of three years, debt funds get the benefit of indexation for capital gains taxation.

Data shows that from the inception of the current series of cost inflation index, 2001-02, the effective rate of taxation on the gains has been less than 10 per cent on an average. The rate of tax on capital gains on equity over a holding period of one year is 10 per cent.

Net-net, if you want your fund manager to do away with the subjectivity of instrument selection and do the broad allocation to asset categories as per market situation, you may go for this fund.

(The writer is a corporate trainer and an author)

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Published on: Sunday, April 10, 2022, 12:54 PM IST