A multitude of factors have kept equity markets extremely volatile in 2022. After soaring past the 18,000-mark in January, the NIFTY fell by more than 2,500 points due to the Ukraine-Russia war, before regaining some lost ground in the past few sessions. In such a scenario, a category of Mutual Funds called “Equity Savings Funds” makes sense for those looking to invest for a 2–3-year horizon with low to moderate risk.
The main problem that Equity Savings Funds aim to solve is an age old one – the trade off between tax efficiency and risk that often leads conservative investors to invest into equity funds for the wrong reasons. 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 into the picture. Per SEBI’s definition, an Equity Saving Fund is an “open ended scheme investing in equity, arbitrage and debt” – so at least 65% of the fund’s assets are required to be invested into equities. How then, you might ask, are they low risk?
The answer to that lies in the fact that a very large chunk of this 65% is expected to be in “arbitrage” or “hedged” equity. Arbitrage is the term given to risk free profit opportunities that arise due to mispricing of the same security in the spot and futures market. When you buy and short-sell same quantities of the stock, and prices converge on or before the futures expiry date, you essentially wind up booking a “risk-less” profit.
In fact, given the volatility and medium-term uncertainty that’s 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.
What are the potential risks involved? An Equity Savings fund relies on the fund manager to make two very critical 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. Debt fund investing just got a whole lot trickier with crude prices soaring and retail inflation coming in at 6.07% a few days back.
Arbitrage returns, once hovering around the 9% mark a half decade ago, have now dropped to just 4-5% per annum. This has further put a spanner in the works for equity savings funds as a category.
Despite the odds, Equity Savings Funds have returns a respectable 8.25% CAGR over the past 3 years, although the 1 -year returns have been lower by around 1%.
Bottom line: should you invest? Well, if you’re a low risk taking investor whose fixated on tax efficiency, you could invest a portion of your portfolio into them – and hope that the fund manager takes the right calls on your behalf!
