Equity Savings Fund is a relatively new category of funds which has emerged from the thought that equity can be used as a savings vehicle. We all know pure equity is wealth creator but cannot be relied on for medium-term savings. Hence Equity Savings Fund is a cocktail of few more asset classes to make it relevant as per the name. Let’s see the details today.

Colin Wright says “Extremes are easy. Strive for balance”.

In life also, balance is not only essential for happiness and well being, but also for productivity and success. We try to strike the right work-life balance, balance between personal and social life or for that matter, the balance between physical and emotional health.

The search for balance holds true even in financial planning. Individual investors are in a question mode when it comes to allocating their investments across asset classes.

The pursuit of higher returns draws investors to equity, but higher returns at times are accompanied by higher risk. Investors seeking comfort in lower risk of debt investments may end up falling short of their capital appreciation goals.

Striking the right balance between asset classes is easier said than done for individual investors. Not to mention the fact that asset class diversification is not a one-time exercise, but requires periodic monitoring.

Use of hybrid funds which invest in debt and equity is one of the ways of diversification.

Traditionally, there have been two types of hybrid funds viz. balanced funds, which are equity-oriented; monthly income plans (MIPs), which are debt oriented.

What are Equity Savings Fund?

Budget 2014 increased the minimum holding period for non-equity funds to qualify for Long-term capital gain taxation from 12 months to 36 months, thereby reducing the attractiveness of debt funds.

Necessity is the mother of all inventions. So this change in Debt fund taxation became starting reason of equity savings fund. Hence it led to the creation of a new product viz. equity savings fund.

Composition of Equity Savings Fund

Equity savings fund try to balance risk and returns by investing in equity, debt, and derivatives.

Use of derivatives reduces net equity exposure (around 20-40%, although it may vary from fund to fund) and consequently protects investors from the volatility of returns.

Further, since equity savings fund have gross equity exposure (without considering derivatives) of more than 65%, they are treated at par with equity funds for taxation.

The equity portion of the portfolio provides potential for higher returns, whereas the debt component provides stability to returns.

Use of derivatives to manage net equity exposure, allows the fund to make the most of market conditions, especially in volatile markets.

Thus, equity savings funds perform a balancing act between risk and return.

From a risk-return perspective, equity savings funds are a notch below balanced funds (more than 65% exposure to equity). Also these are a notch above Monthly Income Plan (MIP) funds, which generally have an allocation of 15-35% in equity.

Why Equity Savings Fund?

• Equity savings funds provide better stability and downside protection as compared to pure equity funds. Downside protection means when the markets fall.
• Equity savings funds are suitable for conservative investors, who seek moderate exposure to equity. Investors with a short time frame (1-3 years), like those approaching retirement, could invest in equity savings funds. They can achieve their wealth creation goals, without running the risk of volatility in equity markets eroding their capital.
• Such Investors could also use Systematic Investment Plan (SIP) to invest into such funds at periodic intervals. This eliminates worry about timing the market. Subsequently, post-retirement, use of Systematic Withdrawal Plan (SWP) to withdraw pre-determined amount at periodic interval can create a reliable pension stream.
• First time investors with time horizon 1-3 years can invest in these schemes as this will help them understanding mutual funds volatility.
• Tax efficiency: Equity savings funds invest more than 65% of their corpus in equity and are thereby treated at par with equity funds for taxation. Consequently, if they are sold within a year, short-term capital gains would be taxed at 15 percent. If they are sold after a year, they qualify for long-term capital gains tax, which is 10% (above 1 Lakh of Capital gains in a year).

This provision makes them more attractive than debt funds where short-term capital gains are taxed at slab rates. The long-term gains in Debt are taxed at 20% with indexation. The minimum holding period for debt funds to be categorized as long-term capital assets is 3 years vis-à-vis 1 year for equity savings funds.

Performance of Equity Savings Fund Category

Capital appreciation potential of these funds is lower than pure equity funds. Equity savings funds score over equity funds and balanced funds in terms of lower market risk. These are more tax efficient than pure debt funds.

Equity savings fund have stricken the sweet spot between attractive returns and risk mitigation. If your portfolio needs it you may look at this category for investments.

If you have a query on these do let me know in the comments section below.