Investment Options for HUFs: Comparing Mutual Funds and Portfolio Management Services (PMS)

In this article:

• What is a Hindu Undivided Family, its advantages, disadvantages and specifically tax benefits
• Choosing between Mutual Funds and PMS, the strengths and weaknesses of each, and how they compare

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Introduction to Hindu Undivided Families (HUFs)

A Hindu Undivided Family (HUF) is a unique concept under Hindu law, where a family forms a single legal entity. It consists of all persons lineally descended from a common ancestor, including their wives and unmarried daughters. The head of the family, known as the 'Karta', manages the affairs of the HUF. This entity is recognised as a separate tax entity under Indian Income Tax Law, which provides it with certain tax benefits.

Structure of HUF

The structure of an HUF is rooted in the traditional Hindu family system. Here’s a detailed look at its components:

1. Karta: The Karta is the head of the HUF and has the authority to manage its affairs. Typically, the eldest male member assumes this role. The Karta has the power to make decisions concerning the HUF’s assets and investments but also carries the responsibility for its liabilities.
2. Coparceners: These are the members who have a birthright to the HUF property. Initially, only male members were considered coparceners, but post the Hindu Succession (Amendment) Act, 2005, daughters are also given coparcenary rights. Coparceners can demand the partition of the HUF.
3. Members: Apart from coparceners, other family members, such as the wives of male members and unmarried daughters, are part of the HUF. While they do not have the right to demand partition, they are entitled to maintenance and share in the HUF assets.
4. HUF Property: An HUF's property includes ancestral property, property acquired through the HUF's business or investment, and property gifted or willed to the HUF.
5. Succession: HUF follows the rules of succession under Hindu law, where the property is passed on from generation to generation. The next eldest member usually takes over the role when the Karta passes away.

Advantages of HUF

1. Tax Benefits: HUFs enjoy tax exemptions and deductions similar to individual taxpayers, including Section 80C benefits and separate income tax slabs.
2. Asset Pooling: Family assets can be pooled together, leading to better investment opportunities.
3. Estate Planning: HUFs can be useful for estate planning, ensuring the smooth transfer of wealth across generations.

Disadvantages of HUF

1. Conflict of Interest: Differences in opinions among family members can lead to conflicts.
2. Lack of Individuality: The HUF's earnings and assets are not attributed to any one individual, which can sometimes complicate financial planning.
3. Legal Complications: Dissolution or partition of an HUF can be legally complex and contentious.

Tax Advantages of HUF

One of the primary benefits of forming an HUF is the tax advantages it offers. Here’s a closer look at these benefits:

1. Separate Tax Entity: An HUF is treated as a separate tax entity under the Income Tax Act. This means that the income earned by the HUF is taxed separately from the individual incomes of its members. As a result, the total tax liability can be significantly reduced.
2. Deductions under Section 80C: HUFs can claim deductions under Section 80C of the Income Tax Act, which includes investments in life insurance premiums, PPF, NSCs, and other specified instruments. The deduction limit is currently Rs. 1.5 lakh per annum.
3. Income Splitting: By transferring assets and investments to the HUF, families can split their income, thereby lowering their overall tax burden. This is particularly beneficial for high-income families.
4. Tax-Free Gifts: Gifts received by an HUF from its members or other HUFs are not subject to tax. However, gifts from non-members are taxable if they exceed Rs. 50,000 in a financial year.
5. Exemptions and Deductions: HUFs are eligible for various tax exemptions and deductions available to individuals, such as deductions for medical insurance premiums under Section 80D and interest on housing loans under Section 24.
6. Dividend Income: Dividends received by the HUF from Indian companies are exempt from tax, subject to certain conditions.

Mutual Funds vs. Portfolio Management Services (PMS) for HUFs

When it comes to investing, HUFs have a variety of options. Mutual Funds and Portfolio Management Services (PMS) are two of the most prominent choices. Each of these investment vehicles has its own set of advantages and disadvantages. Here’s a detailed comparison to help HUFs make an informed decision.

Mutual Funds

Mutual Funds are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, and other securities. These funds are managed by professional fund managers.

Strengths

1. Diversification: Mutual funds offer exposure to a wide range of securities, which helps spread risk.
2. Professional Management: Funds are managed by professional fund managers, which can lead to better returns compared to individual stock picking.
3. Liquidity: Mutual funds are highly liquid, allowing HUFs to redeem their investments easily.
4. Tax Benefits: Equity-linked savings schemes (ELSS) provide tax deductions under Section 80C of the Income Tax Act that apply to HUFs.
5. Low Minimum Investment: Investors can start with a relatively small amount, making mutual funds accessible to a wide range of investors.

Weaknesses

1. Market Risk: The value of mutual fund investments can fluctuate with market conditions.
2. Fees and Expenses: Management fees and other expenses can eat into returns.
3. Limited Control: Investors have no control over the specific investments made by the fund manager.
4. Performance Variation: The performance of mutual funds can vary significantly based on the fund manager’s strategy and market conditions.

Portfolio Management Services (PMS)

PMS is an investment service offered to HUFs in which a professional portfolio manager manages the client’s investment portfolio. PMS is typically tailored to the investor’s specific needs, providing personalised investment solutions. Read more 👉🏽 What are Portfolio Management Services? A guide for investors in India

Strengths

1. Customised Portfolios: PMS offers tailored investment strategies based on the financial goals and risk appetite of the HUF.
2. Professional Management: Portfolios are managed by experts, which can lead to optimized returns.
3. Transparency: Regular updates and detailed statements keep investors informed about their portfolio performance.
4. Direct Ownership: Investors have direct ownership of the securities in their portfolio, providing greater control and transparency.
5. Flexibility: PMS allows for more flexible investment strategies, including active management and tactical asset allocation.

Weaknesses

1. High Minimum Investment: PMS typically requires a high minimum investment of ₹50L, which may not be feasible for all HUFs.
2. Higher Costs: Management fees and performance-based fees vary significantly between PMSs and can be significantly higher than mutual funds.
3. Risk: Despite professional management, PMS investments are subject to market risks.
4. Less Liquidity: Some PMS portfolios may have lower liquidity than mutual funds, making it harder to convert investments to cash quickly.

Key Comparisons

1. 1. Investment Amount: Mutual funds generally require a lower initial investment than PMS. This makes mutual funds more accessible for smaller HUFs or those just starting their investment journey.
   2. Management and Control: PMS offers a more personalised approach with direct ownership of securities, while mutual funds offer pooled investments with professional management but less direct control.
   3. Costs: Mutual funds typically have lower management fees and expenses than PMS, making them a cost-effective option for many investors. PMS, on the other hand, justifies higher fees with customised and potentially higher-performing portfolios.
   4. Transparency and Reporting: PMS provides detailed and frequent reports on portfolio performance, allowing investors to track their investments closely. Mutual funds also offer transparency, but investors have less control over individual investment decisions.
   5. Risk and Return: Both mutual funds and PMS are subject to market risks. However, PMS can tailor the risk profile according to the HUF’s preferences, potentially offering higher returns for higher risk. With their diversified nature, mutual funds may offer more stable but potentially lower returns.

Feature	Portfolio Management Services (PMS) for HUFs	Mutual Funds for HUFs
Minimum Investment	High (usually INR 50 lakhs or more)	Low (can start with as little as INR 500 for SIPs)
Customization	Highly customized and tailored to the HUF’s financial goals and risk appetite	Standardized investment plans; same portfolio for all HUFs in a particular scheme
Management	Managed by professional portfolio managers with personalized strategies for the HUF	Managed by professional fund managers; standardized approach for all investors in the fund
Ownership	Direct ownership of securities in the HUF’s portfolio	HUF owns units of the mutual fund scheme
Fees	Higher fees, including management fees and performance-based fees	Lower fees, including expense ratios and management fees
Transparency	High transparency with detailed and frequent performance reports for the HUF	Regular updates and reports but less detailed compared to PMS
Liquidity	Generally less liquid; withdrawals may take time depending on the nature of the investments in the HUF’s portfolio	High liquidity; units can be easily bought or sold based on NAV
Control	Greater control and involvement for the HUF in investment decisions	Limited control; fund manager makes all investment decisions
Risk and Return	Potential for higher returns due to personalized strategies, but also higher risk for the HUF	Diversified risk; returns vary depending on the scheme and market conditions
Regulation	Regulated by SEBI, with more relaxed guidelines compared to mutual funds	Regulated by SEBI with stringent guidelines ensuring investor protection
Tax Efficiency	Tax treatment depends on the underlying securities; generally similar to direct equity investments for the HUF	Tax benefits available for specific schemes like ELSS; capital gains taxes applicable based on the holding period
Reporting Frequency	Quarterly or more frequent performance reports provided to the HUF	Typically quarterly, but monthly factsheets and annual reports are also available

 

Conclusion

Both Mutual Funds and Portfolio Management Services (PMS) present viable investment options for Hindu Undivided Families (HUFs) in India. Mutual funds are accessible and cost-effective, providing diversification and professional management. They are an excellent choice for HUFs looking to start with lower investment amounts and seeking liquidity.

Conversely, PMS offers a more personalised investment strategy, professional management, and greater control over the investment portfolio. It suits HUFs with a higher investment capacity and those seeking tailored investment solutions with potentially higher returns. However, selecting the right PMS requires a structured evaluation process. Read our comprehensive guide 👉🏽 How to choose the best PMS to invest in India

Ultimately, the choice between Mutual Funds and PMS will depend on the HUF’s specific financial goals, risk appetite, and investment horizon. Considering these factors, a well-informed decision can help achieve the family unit’s financial stability and growth objectives.

With a strong track record and mix of quantitative and fundamentally driven investment strategies, Capitalmind PMS has delivered sustained investment returns for our HUF clients. To know more 👉🏽 Capitalmind PMS investment strategies and updated performance.

Other Recommended Reading

What are Portfolio Management Services? A guide for investors in India	The basics of what Portfolio Management Services are, minimum investment required in PMS, how PMS operate, benefits and drawbacks to consider
Looking for the best PMS for your investments? Take a look at Capitalmind PMS	One concise page with information about Capitalmind PMS, its strategies and daily-updated performance since inception
How to choose the best PMS in India?	Looking at short-term returns is one the ways investors make the mistake of identifying the right PMS for their needs. Here's an objective framework to make that important decision
How to invest a lumpsum amount	Practical considerations of how to think about investing a lumpsum amount
The advantages for Accredited Investors in India	By meeting certain criteria, experienced investors can get access to beneficial terms for investing in various investment vehicles including PMS and AIFs.

Contact our team to learn more about Capitalmind PMS and get a customised strategy consultation.