What is the difference between ETFs and FOFs?
There have been so many new alterations in the Indian investment industry that sometimes it might get difficult for investors to keep abreast with what is new and what is rudimentary. The introduction of market linked schemes like mutual funds has given the common man an opportunity to create wealth over the long term. However, systematic investing is essential to create long term wealth as it is almost impossible to become wealthy overnight. Wealth creation is a term which is interpreted differently by every individual. While creating long term goals, investors must be realistic for their financial planning to work effectively. Investors should keep their existing liabilities, income, age, and risk appetite in mind while setting long term financial goals.
To target these long-term goals, more and more investors are turning towards mutual fund schemes like ETFs and FOFs. What is the difference between these two? Are ETFs and FOFs two sides of the same coin? To understand the similarities / differences between these two continue reading.
What are ETFs?
Exchange traded funds are quite popular among Indian investors because they follow an interesting investment strategy. An exchange traded fund is an open-ended scheme which tracks or replicates a particular index. For example, Gold ETFs. According to the guidelines set forth may market regulator SEBI (Securities and Exchange Fund of India), an ETF “is an open ended scheme which replicates/tracks the particular index. Of the total assets, this fund must invest a minimum of 95 per cent in securities of a particular index (which is being replicated or tracked)”.
What are FOFs?
Market regulator SEBI describes fund of funds as, “a scheme that invests primarily in other schemes of the same mutual fund or other mutual funds is known as a FoF scheme. A FoF scheme enables the investors to achieve greater diversification through one scheme. It spreads risks across a greater universe.” Fund of Funds are open ended equity schemes which aim at generating capital appreciation over the long term by investing in other funds that follow a particular theme. For example, Global FOFs.
Difference between FOFs and ETFs
|Definition||ETFs are a basket of diversified securities held in the ETF portfolio to help the scheme outperform its underlying benchmark with minimum tracking error||FOFs are a basket of mutual funds who invest in other mutual fund schemes to achieve their investment objective|
|Management||ETFs are passively managed funds||FOFs are actively managed funds|
|Expense ratio||The expense ratio of ETFs is low as compared to FOFs||Since these are actively managed funds, the expense ratio of FOFs is high|
|Liquidity||ETFs can be traded at the stock exchange like any other company stock, thus offering more liquidity||One cannot trade FOFs like ETFs and hence have low liquidity|
|Market price||The selling / buying price of an ETF is determined by its demand and supply at the exchange||The buying / selling price of FOFs is determined by its existing NAV|
What is the taxation on ETFs and FOFs?
For equity ETFs redeemed before one year from the date of investment, a short term capital gains tax of 15% is applicable. For ETF units redeemed after one year, a long term capital gains tax of 10% is levied for gains exceeding Rs. 1 lakh.
For gold and other ETFs, units redeemed within three years from the date of investment are deemed as short term capital gains and a STCG tax is levied. STCG tax is calculated by adding the gains to your annual income and you will be taxed according to your tax slab. For units redeemed after three years, an LTCG tax of 20% is levied with indexation benefits.
FOFs are taxes as debt schemes irrespective of which asset class / commodity / sector it invests in.