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An Exchange Traded Funds or ETF are the collection of securities that mostly tracks an index. Same as mutual funds, they also contain many types of investments, including stocks, bonds, commodities, etc. Like ordinary stocks, the ETFs are listed and traded in the stock exchanges.
Fund of Funds or FOF is open-ended mutual funds consisting of a basket of mutual funds. The FOF collects money from the investors and invests in one or more mutual fund schemes. The FOF can either invest within the same mutual fund house or other ones. FOF is not traded on the stock exchanges.
Let us understand the primary differences between the ETF and FOF:
ETFs are traded at stock exchanges; hence the value of an ETF depends upon its demand and supply, i.e. they are available at the market price. Since ETF are bought and sold (traded) in the market, their price fluctuates all day. Their price can vary and could be more or less than their Net Asset Value (NAV).
FOF works like mutual fund schemes. Unlike an ETF, FOF trades only once per trading day. Hence, they are less liquid than ETFs. Their price is calculated at NAV at the end of the trading day.
The expenses related to an ETF is lower than that of FOF. The brokerage cost is dependent on each trade. However, purchasing an ETF reduces trading securities individually and therefore minimises the brokerage commission.
The cost of FOF includes the management fees of all the underlying funds. Hence, the expense ratio is high for FOF.
An ETF can comprise stocks of one industry, or it can own stocks of various sectors. There are many ETFs, such as Bond ETFs, Industry ETFs, Commodity ETFs, Currency ETFs, Inverse ETFs, etc.
Whereas the FOFs can be categorised as gold funds, international fund of funds, multi-manager fund of funds and asset allocation funds.
The tax on redemption of equity ETFs depends on the period of holding. If the holding period is more than a year, then there is long-term capital gain. It is exempt if the gain is up to Rs.1 lakh. For long-term capital gain of above Rs.1 lakh, the tax liability is 10% without indexation benefits. However, if the holding period is less than 12 months, then 15% tax liability arises from short-term capital gain.
In ETF (other than equity) and FOF, if the holding period is less than 36 months, there is short-term capital gain. Income from such sales is included in the normal income, and tax is calculated as per normal slab rates. Also, the tax liability of 20% (with indexation benefits) is calculated if long-term capital gain arises from selling such assets. The FOFs are treated as debt funds regardless of any of the schemes they invest in.