WHEN THE HOLDING period is expected to be less than three years, your options in the mutual fund universe may seem limited as a short period leaves little room for risk. Pure equity funds go out of such an equation. In debt funds, though, returns may be reasonable, taxation cuts into return. This is where equity savings funds come in. Being equity-oriented, their tax treatment is more favourable than debt funds. Plus, equity savings funds hedge the better part of their equity exposure. So, the risk level is well within limits for short-term periods of one to three years. This is the reason why when markets seem confusing, equity savings funds are a clear choice.
Equity savings funds form a key component of the hybrid schemes. There are 22 mutual funds that can be classified as equity savings funds. Put together, they manage Rs 16,000 crore in assets under management. There are 3.6 lakh investor accounts associated with equity savings funds.
Equity savings funds could be an attractive option in the current backdrop due to three factors. One, signs of expected volatility in equity markets are visible. Two, there is interest rate volatility in the fixed income space. Third, equity valuations are not cheap. Thus, equity savings funds are ideal for investors who are looking for relatively stable returns with low exposure to equity. Or, investors looking for an alternative for parking funds with measured equity allocation or investors looking for an investment avenue that can complement arbitrage schemes in the current volatile environment.
The main objective of equity savings funds is three-fold:
Low-beta: This is done by investing in a handful of stocks and the aim is to keep the beta of the portfolio low.
Risk-adjusted returns: A combination of derivative strategies and fixed income is used to achieve this aim.
Taxation: Equity savings funds are taxed like pure-equity funds on account of gross equity exposure of 65 per cent or more. Additionally, arbitrage exposure for hedging risks helps maintain equity taxation.
Different mix for different markets:
Equity savings funds aim to limit downside when there is volatility and aim to generate potential returns when markets are stable. This twin approach is ensured by a layered portfolio approach. In the first layer there are gross equities, stock arbitrage for hedging and debt/cash. Delve deeper and you will find in the second layer are net equities that give concentrated exposure to a handful of stocks. In the third layer, there could be call option writing, usually deployed in a range bound market. It helps in generating income in the form of premiums.
In different types of markets, the mix in equity savings funds work differently. In a bull market, net equities help capture upside. Writing call option delivers premium for accrual income. Arbitrage gives the accrual income plus portfolio balancing opportunity. In a flat market, all three strategies other than equity will help deliver returns. In a bear market, writing call option, arbitrage and debt counterbalances the potential for negative return.
Equity savings funds can be used by any investor with a timeframe of one to three years. It is good for those in the higher tax-brackets, since it is a more tax-efficient option. Risk averse investors can also experiment with equity savings funds given the minuscule unhedged equity exposure.
While there are several fund in this category, one of the consistent performers here is the ICICI Prudential Equity Savings Fund. The fund is known for its conservative approach and steady performance.
For an investor looking to invest in this category, it is important to understand that your chosen fund has a clear strategy and is consistently following it. Also, do remember to check if the fund in the past has done the job of containing volatility downsides well.
Bharat Bhatter is Managing Partner, Ishpar Growth Partners LLP from Chennai