Equity savings funds

A new variant is added in the best equity mutual fund basket, which is Equity Saving Funds. Also, a part of it is hedged, and then some debt is added, and you have this new fund category. Before we get into this product’s details let us know the reason for which this new category is started doing well in the mutual fund industry.

According to the previous budget, the holding period for debt mutual funds has been increased by the government to three years. Only by keeping invested for three years would you get the indexation benefits. Otherwise, you need to pay tax at the applicable slab rate. This means debt-oriented and debt funds like Monthly Income Plans(MIPs) can have the same tax treatment as FDs for holding it up to 3 years.

Features of Equity savings funds

Equity saving funds have a fixed target to generate returns from

  • Equities,
  • Arbitrage trades,
  • And fixed-income securities.

Equity saving funds restrict debt, which is fixed income, exposure to 35 percent. To reduce fluctuations and protect a portfolio, these types of funds actively use derivative strategies.

  • In addition, till now a part of equity is still unhedged(pure equity cash market) to increase the returns of the portfolio. The exposure of derivative and equity here is examined as equity allocation.
  • The unhedged equity exposure typically ranges between 15 percent to 40 percent,
  • And the rest of the portfolio is hedged to gain from arbitrage opportunities.
  • Also, before knowing what these funds are and whether they will suit you or not, it is necessary to know that these funds cannot build long-term wealth as efficiently as pure equity funds.
  • Moreover, none should view these in the same light as equity for long-term portfolios. What equity savings funds provide is stability and tax efficiency; the latter when comparing these with the debt.
  • These types of funds are best for those looking for some equity exposure but don’t have a very long time frame. They suit those investors having a low-risk appetite and looking for less uncertainty in returns. Many of these types of funds seek to provide dividend income although it is not mandatory to do so.
  • And so, they are not substitutes for pure equity funds, especially for long-term portfolios, and suit those with a 2-3 year time frame who need the tax benefits that are not present in debt-oriented funds for a short time period.

Read more:  Debt mutual funds vs fixed deposits

Positioning

If you are plotting the fund categories on a risk-return axis, funds have positioning between MIP funds and balanced mutual funds. Also, they are better than the  MIP/debt-oriented funds, but not as good balanced funds in their risk-return proposition.

How does arbitrage generate returns?

In Equity savings fund, a third of the money is invested in equity, one-third of the amount is invested in arbitrage which is like liquid fund and one-third of the amount gets invested in fixed-income securities. We all know how equity and fixed income fund operate let us understand how are arbitrage funds generate returns.

Arbitrage schemes were earlier treated as equity schemes for the purpose of taxation. This means they used to enjoy zero tax on long-term capital gains earlier. This tax advantage made them the favorite of mutual funds investors, especially those with huge amounts to park for a short period. After the reintroduction of LTCG tax, long term capital gains of above Rs 1 lakh in a financial year are taxed at 10 percent.

  • Fund managers India suggest that there are significantly higher arbitrage chances in a bull market, but lesser at the time of falling or flat markets.
  • Let’s take an example that ABC Ltd. is trading in the National Stock Exchange (NSE) cash market for Rs. 100, and Rs. 101 (futures price of the same month) in the futures markets. At the end of the month, the future price converts with the cash price. Therefore buying in the cash market and selling in the futures market will get a gain of 1 percent. We may assume a 0.2 percent of brokerage for these type of transactions, then the net gain is 0.8 percent or an annualized return of 9.6 percent

Must read: Sensex Guide

Category Performance: Equity savings funds

  • It is stated that many of the mutual funds in this category are of recent origin, without much of a track record.
  • Also, when reviewing mutual fund performance so far, it looks like they have done well in relation to the CNX Nifty.
  • In the above chart, the Nifty is falling by 5 percent, while equity savings funds are delivering positive returns that range between 1.6 percent to 3 percent in the last six months. Their arbitrage component and debt component help these funds in down markets.
  • Absolute Returns also follows a similar strategy but may take a much greater unhedged equity disclosure.
  • You need to check this information before investing in these schemes.
SchemeUnhedged Portion
Birla Sun Life Equity Savings Fund – Reg. – Growth20% – 45%
ICICI Prudential Equity Income Fund – Reg. – Growth20% – 40%
Kotak Equity Savings Fund – Reg. – Growth15% – 25%

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Equity savings funds – How they stack up

OptionAdvantageDisadvantage
Fixed DepositFixed ReturnTaxed at a stable rate
Short Term Debt FundsRelatively stableLimited return potential and taxed at slab rate if  held for less than 3 years
Long Term Debt FundsFewer fluctuations compared to hybrid funds and superior post-tax returns over the medium term when compared with FDsMore fluctuations than short term debt funds and taxed at a slab rate if held for less than 3 years
Hybrid Mutual Funds with Moderate Exposure To EquityRelatable stable debt investments and moderate exposure to equityTaxed at slab rate if held for less than 3 years
Equity FundsGood growth potential and no-long term capital gain taxHigh fluctuations in the short term
Equity Saving FundsIncome through stable debt investments and arbitrage opportunities; growth from moderate exposure to equity. Also, no long term capital gains tax.Moreover, during falling equity markets, fewer returns from the arbitrage portion, and negative returns from the unprotected net equity portion.

Conclusion

  • The unhedged equity portion differs from fund to fund, and also varies in different time periods. Higher the unhedged portion (net equity exposure), Higher the fluctuations.
  • Income through stable debt investments and arbitrage opportunities has growth potential from moderate exposure to equity. Also, no LTCG tax.
  • Pure arbitrage funds protect their cash positions and then, the returns through the market movement (from unhedged equity) are ruled out. Also, equity savings mutual funds, there is a great chunk of unprotected equity that is capable of generating returns higher than arbitrage funds. Also, to this extent still, equity savings funds carry far greater risk and return potential than arbitrage funds.

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