What are Equity Savings Funds?

SEBI has recently recategorized Mutual Funds, and “Hybrid: Equity Savings” is a relatively underserved category – with less than half of all AMC’s offering them as on date. For this reason, we’re quite likely to see a spate of NFO’s (New Fund Offers) in this pace in the coming months. Investors are justified in asking, “Kya Equity Savings Mutual Funds Sahi Hai?”. Let’s simplify them for you.

Here’s the context behind Equity Savings Mutual Funds - the trade off between tax efficiency and risk that often leads conservative investors to invest into equity funds for the wrong reasons. As you might be aware, Capital Gains from Debt Mutual Funds (which are more suitable for low risk takers) are taxed as regular income, whereas Long Term Capital Gains booked in Equity Oriented Funds are tax free up to Rs. 1 Lakh per fiscal year.

This is where Equity Savings come in. Per SEBI’s definition, an Equity Saving Fund is an “open ended scheme investing in equity, arbitrage and debt”, and they need to hold at least 65% of their assets in equities. I’m sure you are wondering by now – how is a fund with 65% equity “low risk” in nature?

The answer to that lies in the fact that a very large chunk of this 65% will be invested into Hedged Equities, through a strategy known as “Arbitrage”. Arbitrage basically a riskless profit opportunity that arising from a stock having different prices on the spot and futures exchanges. When you buy and short-sell same quantities of the stock, and prices converge on or before the futures expiry date, you book a risk-less profit. In fact, given the high valuations prevalent in the equity markets today, we’re likely to see fund managers holding no more than 20% to 25% of their portfolios in unhedged equities, thereby bringing down the risk factor considerably.

The picture I’snt all rosy, though. Most equity savings funds have delivered sub-FD rate returns in the past year. After all, an Equity Savings fund relies on the fund manager to make two important decisions: just how much to hold in unhedged equities, and what style of investing to adopt for the debt portion that could range from 10% to as high as 35% of the portfolio – and fund managers are definitely not always going to get it right! Arbitrage returns, which used to be in excess of 9% just 5-6 years back, have now dropped to just 5-6% per annum – the same as short term liquid fund returns. This will further act as a dampener to Equity Savings Fund returns.

Bottom line: should you invest in Equity Savings Funds? The real question is – are you not more likely to generate better returns by combining top performing equity funds, with an arbitrage fund and a debt fund? Most likely, yes. But if the thought of selecting funds and managing your portfolio actively is too painful for you, and you’re a low risk taking investor whose fixated on tax efficiency, you could invest a portion of your money into it – and pray that the fund manager takes the right calls on your behalf!