Motilal Oswal Nasdaq 100 Fund of Fund: Do not invest!

Published: November 13, 2018 at 10:24 am

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Here is why you should stay away from Motilal Oswal Nasdaq 100 fund Of fund (MOFN100FOF) that will invest in Motilal Oswal Nasdaq 100 ETF (MOFN100). The NFO for this fund of fund is open between 9-22 Nov 2018 and it will subsequently operate as an open-ended fund. However, say no to it if your distributor or bank RM suggests it to you. Not because it is an NFO. Not because of Nasdaq 100, but because it is unlikely to make a difference in your portfolio. Allow me to explain.

What is a fund of fund?

A mutual fund invests in other mutual funds or exchange-traded funds are called fund of funds. All fund of funds in India are taxed liked debt mutual funds unless they invest in Indian ETFs. So Motilal Oswal Nasdaq 100 fund Of fund is a debt mutual fund from a tax point of view. So gains from units less than or equal to 3 years old at the time of redemption will be taxed as per slab. Gains from older units will be taxed at 20% with cess after inflating the purchase price using the cost inflation index (aka indexation).

What is the Nasdaq 100?

Nasdaq is the second largest stock exchange in the world in terms of market cap (next to the New York stock exchange). The Nasdaq-100 Index launched in Jan 1985 has 103 of the largest (in terms of market cap) domestic and international companies excluding financial companies and investment firms listed on the Nasdaq exchange. Because of this, the index is dominated by technology giants. This is the current sector-wise composition. (this link will also give you the full list of stocks)

sector-wise breakup of the Nasdaq 100 as on 11th Nov 2018. Motilal Oswal Nasdaq 100 Fund of Fund will be investing in this index

There are two reasons why the Nasdaq 100 looks promising from an Indian point of view: (1) diversification across international stocks (available in a single index) and (2) the presence of giants like Apple, Microsoft, Facebook, Amazon, Adobe, Intel, Starbucks, Paypal. It is a list of whos-who!

10-year rolling return performance of the Nasdaq 100 (adjusted for dividends and splits)

If you want to look at past performance, don’t just look at one data point and assumption this is great for you. These are 2306 10-year rolling returns calculated from 13th Jan 1999 to 9th Nov 2018. Source: Yahoo Finance

10-year rolling return performance of the Nasdaq 100 (adjusted for dividends and splits)

Notice that after the 2008 crash, returns quickly climbed to around 10% and stayed there for an incredible four-year period with a small uptick recently. We will discuss what this means below. Note: these returns are for the US investor (before expenses and taxes, still a well above their inflation). The Indian investors will have to factor in FOREX growth rates as well. We will do this below.

What do we know about Motilal Oswal Nasdaq 100 ETF?

This was started in March 2011 but only has about 94 crores and 4,912 folios only  (no commissions means no sales) and even poor liquidity Source: MOFN100FOF scheme document (page 24). This has one of (if not the) worse nav to price difference for an ETF in India. If ETFs are new to you, you can read more about them here: How ETFs are different from Mutual Funds: A Beginner’s Guide and Interested in ETFs? Here is how you can select ETFs by checking how easy it is to buy/sell them

You can see the NAV and price of the ETF plotted below along with the 30-day moving minimum and max of the difference between price and NAV.

Motilal Oswal NASDAQ 100 Exchange Traded FundHave a look at the atrocious Price-nav percentage difference.

price to nav difference of the Motilal Oswal Nasdaq 100 ETF

This means that if you are holding these ETF units, you will not easily find a buyer as the price is much higher than the NAV. There is a high demand for buying these ETF units. but at least for now, not many sellers.

Will the introduction of this FOF create better liquidity in the ETF?  The fund manager of the FOF will buy ETF units directly from the fund manager of the N100 ETF or from the stock exchange (secondary market). Unless the FOF sees regular investments and redemptions which are routed through the secondary market, the ETF liquidity is unlikely to improve.

Motilal Oswal Nasdaq 100 Fund of Fund: Advantages

In an ETF, the retail investor can typically only sell with other investors. The AMC will buy these units if there are no other taker, but these will take a few days. This lack of liquidity is minimized (not eliminated)  in a fund of fund. We can buy and sell any amount with the AMC and it is their headache to create the units and buy them back upon (when we sell). Liquidity is not a problem for Nasdaq 100 stocks and as long as they have a proper international broker, it should not be an issue. Well, that is about the only advantage.

MOFN100FOF: Disadvantages

  • The fund of fund will have a NAV that tracks the price of the N100 ETF. Since there is a huge disparity between the price and nav of the ETF, this will also lead to a disparity in the returns of the fund of fund and lead to significant tracking error. This one reason al0ne should be enough to avoid Motilal Oswal Nasdaq 100 fund of fund
  • The ETF will hold 5% cash to handle redemption pressures. So will the fund of fund. So this makes 10% cash in total and that much less exposure in the NASDAQ 100. This cash holding will also result in a distinct and constant tracking error (difference in returns between the index and the fund of fund)
  • MOFN100 (ETF) has a ~ 0.5% expense ratio. The fund of fund will have an additional ~ 0.1% expense ratio (for the direct plan. The regular plan will have higher (~ 0.5%)
  • The fund of fund will be taxed as a debt fund as mentioned above. Since this should be a long-term investment, one can expect (as per current laws that can change for the worse) to pay about 15-17% effective tax post indexation on the gains (if any!)
  •  The US market may appear nice and stable, but it if falls, it falls big (see the 10Y returns around 2009 above). The current fluctuations add an additional layer of volatility in the returns. So the usual nonsense like “invest for the long-term” etc will not work here (or anywhere else).

You can get details about the FOF from the AMC site

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US INR Exchange rate history and how it will impact investments in the Nasdaq 100

If you look at the price of gold vs time or the USD-INR exchange rate with time, it appears as if the growth rate is “huge”. In reality, it is not so.

US INR Exchange rate history and growth rate

Now let see how this forex growth rate will enhance returns from  NASDAQ 100. Let us assume that the 10Y return expectation from the NASDAQ is 8% (accounting for expense ratio, but not tax) assuming we do not see huge crashes. If there a 40% crash, you will get next to nothing. after 10 years. We shall also assume that the USD-INR rate grows year on year at a rate of 4%.

Suppose you buy NASDAQ units for Rs. 10,000.  and one USD is Rs. 70. So you will be buying units for ~ $ 148.8. This amount grows at an 8% CAGR for ten years to $ 308.4. Meanwhile, the exchange rate has now become Rs. 103.6 per USD (at 4% CAGR). So after 10 years, you will have

= 103.6 x 308.4 = 31957.4 INR. This corresponds to a CAGR of 12.32% (a little more than 8% + 4%). If you remove about 16% tax (LTCG at 20% with indexation will be lower than 20% flat), then CAGR is about 10.4%.

Why avoid Motilal Oswal Nasdaq 100 Fund of Fund?

So, the index is wonderful, the forex rate is favourable, the FOF minimises the risks associated with the ETF (although it is exposed to its illiquidity), but then why are you saying avoid it? Yeah, yeah I agree with all of this, but what most people fail to understand is the importance of asset allocation in the portfolio. Allow me to explain with an example.

In 1997 when I started my PhD and started using computers, the brand new WIN’95 machine in my lab had a storage issue. So I was asked to remove files and create some disk space. So I listed all the files in C: and started removing one by one. After an hour so, my supervisor came by and was surprised to find that I was still at it. He then realised that I was focussing on kilobyte sized files and not the large ones. So he taught me a lesson that I never forgot: focus on stuff that creates the most impact. Don’t spend time worrying about peanuts. Well, he meant, arrange the files by size and delete the largest ones that were not useful and be done with it. The same applies to our investment portfolio as well.

Sure, the Motilal Oswal Nasdaq 100 fund Of fund is a good way to invest in the NASDAQ 100 (which in of itself is a fantastic index). However, how much are you going to invest? How much of your portfolio will have exposure to this fund? I am willing to wager that for most people interested in this it will be not more than 5%, rarely 10%.

Just because it is a good investment, will you allocate 20%/30%/40% of your portfolio to this index and face the prospect of huge crashes and extended sideways movements? (why do you think the 10Y returns are so poor prior to 2011?). At 5% or so, what great difference will it make to your portfolio?

Yes, yes “diversification with international stocks” is a good thing (for lower volatility, not higher returns), but this implies significant exposure. Take a balanced fund or aggressive hybrid fund for example. It has 25-30% bond exposure at all times with periodic rebalancing to deliver equity fund like return at lower risk. Most investors are unlikely to have this kind of exposure in MOFN100FOF and even if they do, how many will rebalance each year and pay tax on gains as per slab because risk management is important? Most investors have a flawed, “let us keep investing and hope it will work in the long -term approach”.

Stop spending time searching for kilobyte sized files like me. Focus on the key players with a minimalist portfolio. If you actually, truly understand the purpose of diversification and lower volatility in your portfolio, use a fund like PPFAS Long Term Value Fund. If you hold enough of it, (min 30% upwards), then you will end up getting a small exposure to international stocks. Of course, it will not be as diversified as Nasdaq 100 and dependent on fund manager risk. It is not a perfect solution but will provide lower volatility (which is what diversification is all about) and favourable taxation (this fund will hold 65% minimum Indian equity at all times).

In summary, having a “small exposure” to Motilal Oswal Nasdaq 100 fund Of fund (as “experts” will now ask you to consider as they need to sell) will not help you in any way – not in terms of returns, not in terms of risk and not in terms of diversification. You will be left with a cluttered kichdi of a portfolio. If you disagree, at the very least, do not start a SIP “for the long-term” in this as it will be a tax nightmare!

Note: Video version of this post will be available today evening. Subscribe to the freefincal youtube channel (press the bell icon to receive notifications)

update: this is the video

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14 Comments

  1. I have always wondered about this concept of “little bit of exposure”.
    If its not atleast 15-20% of our portfolio, then I don’t think it will have any sizable impact (positive or negative).

  2. >>The fund of fund will be taxed as a debt fund as mentioned above. Since this should be
    >>a long-term investment, one can expect (as per current laws that can change for the
    >>worse) to pay about 15-17% effective tax post indexation on the gains (if any!)
    Could you explain this more?
    For long term investment, the would much lower post indexation.

  3. Sir as of today the price has correctly significantly with regard to the NAV and there is only a 12rs difference between the two.

  4. Hello Prof. Pattu, Are there any other options apart from International Equity for diversification in our Portfolio? What is your opinion on REITS, hopefully to be launched next year?
    Thanks.

  5. Pattu sir, had a question. Given the wide difference between NAV and price, assuming that APs start creating fresh units to Arbitrage the price, the price will keep falling right? That means people buying at market prices will keep getting lower returns as the price is arbitraged out. Is my understanding correct? Thanks for the awesome article.

  6. Apart from tax incidence, its an attractive proposition:
    (1) Nasdaq n100 ETF is a top performer. If someone wants to invest in nasdaq from India, this is the most cheapest way.
    (2) Liquidity of Nasda n 100 ETF is poor. Even if you buy- selling is tough
    (2) FOF N100 helps clear the above liquidiy problem. It tracks Nasdaqn100 etf and should record the same gain/ returns as Nasdaqn100 etf. So the decision to invest in FOF should be only for investing in nasdaq etf or not

    Am I missing anything on the above?

    Hope I am not missing anything

  7. The fact that the author lays down between price and NAV- thats the game and pudding in the icecream- don’t buy when Price> NAV. Simple. Which stock in this world gives that analysis before market opens my friend.

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