Making sense of Sebi’s passive ELSS funds for investors
Premium- Active ELSS funds allocate a minimum of 80% to equity & the rest to debt instruments
Opening up another investment avenue for investors, the Securities and Exchange Board of India (Sebi) recently allowed Indian mutual fund houses to launch passively managed open-ended equity-linked savings schemes (ELSS).
However, fund houses can only have either an actively-run ELSS scheme or a passive one.
Further, the markets regulator has mandated that the passive ELSS scheme should be based on one of the indices comprising of equity shares from top 250 companies in terms of market capitalization.
ELSS is the only tax-saving mutual fund category, under which an investor can avail of a maximum tax deduction of up to ₹1.5 lakh in a financial year under section 80C of the income-tax (I-T) Act.
Active ELSS funds, which most fund houses currently offer, allocate a minimum of 80% to equity and the rest to debt instruments and the money gets locked in for a period of three years.
Apart from the tax-saving benefit, ELSS schemes also work as an investment option, as this category has delivered an average return of 12% on a three-year basis and 15% on a 10-year basis.
We look at whether passively-managed ELSS schemes will work for investors.
Dhaval Kapadia, director-managed portfolios, Morningstar Investment Adviser India
Passive ELSS funds would be low cost
Generating alpha for active funds has been challenging over the past few years for Indian mutual fund houses. In the ELSS category, less than 30% of the funds have been able to beat the BSE 500 (total return index) based on three-year and five-year annualized returns (as on 24 May 2022). Over the past one year, less than 40% of the ELSS funds have outperformed the BSE 500 index.
In such a scenario, providing an option of passive funds in the ELSS category makes sense.
Relative to active funds, passive funds would be low cost. Further, as per Sebi’s recent guidelines for passive ELSS funds, the underlying index being tracked by the fund should comprise the top 250 stocks by market capitalization. This provides an option to invest in a fairly wide basket of stocks across large-caps and mid-caps.
Sivananth Ramachandran, Director of capital markets policy (India), CFA Institute
Active ELSSs seeing underperformance
The main argument for a passive option is the underperformance of active ELSS schemes compared to the benchmark in recent years. There are some caveats, including the fact that benchmark returns are not adjusted for fees—about 25 bps on average across index funds based on my calculations. Even with the fees, more than half the schemes would have underperformed. The performance disadvantage of active ELSS is not one-off either; the corresponding numbers at the end of 2020 were worse.
ELSS is one of the attractive tax saving options and introducing passive ELSS improves investor choice and outcomes. Tax saving choices are usually made closer to the last day, when people have very little time to evaluate options—from that perspective, passive ELSS minimizes regret.
Tarun Birani, Founder & CEO, TBNG Capital Advisors
Indexing helps limit behaviour bias
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Passive ELSS funds make total sense, as a tax-saving alternative when clubbed with an opportunity for novice investors or busy professionals to dive into investments via the low-cost passive route. While these investments are now limited to exposure to large-cap funds, individuals with long-term investing goals can take advantage of this opportunity. Indexing has demonstrated good investing experience over the long term. Along with low-cost, indexing helps in reducing person-oriented behaviour bias in investing.
The decision may not be entirely favourable for fund houses, especially given that most of them already have active funds in their portfolio baskets. It remains to be seen whether Sebi will open its doors to allow fund houses to launch both products.
Sorbh Gupta, Fund manager-equity, Quantum Mutual Fund
Passive ELSS funds to take time to develop
From an investor perspective, passive ELSS fund will be a good option. However, most of the fund houses, including ours, already have an active ELSS plan. Further, even if a fund decides to launch a passive fund, it will at least take three years, because they would have to wind down the active scheme. Also, a passive ELSS can be based on different indexes. Some houses might replicate a large-cap, while others might replicate some other index. Though there is a restriction to top 250 stocks, we think that there will be no homogeneity on what the product can be, and how they will be compared to each other. So that’s a challenge.
In ELSS funds, the investment gets locked in for three years. So, fund managers could think long term in deploying that money. Active funds still make more sense in this category compared to a passive one.