In this article
What is Equity Savings Scheme?
Equity savings invest the total fund amount between equity funds, debt funds and arbitrage. This scheme is a relatively new financial instrument introduced to the Indian money market. Diversification of fund investment helps to neutralise the volatility related to the stock market to quite an extent.
The investment pattern followed by Equity Savings Fund is what sets it apart from other traditional investment schemes. With ESS, approximately 30%-35% of total investment corpus is invested in equity assets while the rest is invested in debt income funds and arbitrages. ESS is somewhat akin to balanced funds in their operations, with an added advantage of arbitrages.
Since these funds invest in a mixture of various segments, they help to maximise returns on investments while maintaining a smart risk and reward balance. Thus, this savings scheme makes for a perfect option for conventional investors who still want to earn high returns from their investments. These are also the ideal option for individuals looking to gain capital to fulfil short term goal in the near future.
Purpose of Equity Savings Mutual Funds
The diverse components of this savings scheme serve different purposes. For instance, the equity portion of this scheme prevents the erosion of investor’s purchasing power, while debt and arbitrage portion of this scheme acts as a cushion to minimise the downside of market fluctuations.
For example, let’s say an investor has held an Equity Savings Scheme for six months, succeeding which the portfolio has shed about 10% of the value. Now, if the debt segment of the scheme generates about 6% annual returns and the arbitrage segment bring about 6.5% returns, then the investor’s loss will be minimised to an extent.
Thus, cumulative return from ESS will only reduce marginally even with the 10% market decline. Whereas, balanced funds or equity market schemes would have generated negative returns, the quantum of which would have depended on the type of stocks in said portfolio.
With this scheme, a specific portion of the equity is considered as security to maximise the returns from an investment portfolio. Thus, this equity, along with the derivative exposure, is cumulatively considered to be equity allocations, and as a result, these funds are treated as equity assets.
Therefore, for the purposes of taxation as well, equity savings funds are treated as equity funds. Investors are thus liable for certain taxes.
The long term capital gains from equity assets and stocks are tax-free if the quantum of gains is less than Rs. 1 Lakh. This corpus of capital gain is taxed at a rate of 10%. However, if the investor holds the funds for less than 12 months, the tax implication will be according to the short term capital gains order, i.e., at the rate of 15%.
Who should Invest in Equity Savings Scheme?
These funds are the perfect investment options for the individuals looking for equity exposure, but lacking the time frame for long term investment. These are low-risk funds but are designed to bear certain returns, unlike other equity assets. Additionally, few of these funds also look to provide investors with dividend incomes on a regular basis, even though they are not mandated to do so.
Thus, investors who do not possess the disposition to withstand the volatility of the equity money market can find the equity savings mutual funds suitable for their needs. Additionally, investors who are just venturing out and want to deviate from conventional saving options can also consider the ESS portfolio.
Also, investors with a time frame of fewer than 24 months for their investments can meet their needs with this investment option.
However, before investing, one should remember that these funds are not substitutes of other funds with pure equity holdings, especially for those with long-term investment portfolios.
- Reduced volatility
With this scheme, since over 50% of the funds are distributed between debt and arbitrage holdings, they offer more stable returns than pure equity holdings. To reduce volatility, fund managers prefer using various derivative strategies. Additionally, the arbitrage portion of the fund effectively capitalises on the inconsistency in prices of funds in different parts of the market.
Thus, ESS is the perfect investment for those seeking stable returns.
- Tax efficiency
Since ESS is treated as equity funds for the purpose of taxation, the tax liability on this investment is reduced to quite an extent. If investors hold the funds for over 12 months, the returns from it below Rs. 1 Lakh are exempt from taxation.
However, investors should remember that if they redeem their gains from this fund before 1 year of its completion, they will be taxed at the rate of 15%.
- Advantage of arbitrage
The arbitrage portion of these funds allows the biggest advantage as far as stable returns are concerned. Most fund houses are well versed with handling arbitrage that allows low-risk returns. Thus, these funds offer a perfect option to those looking for stable gains from their investments.
- Portfolio diversification
Top equity savings funds offer a diverse investment portfolio through a single investment channel. Thus, investors do not need to analyse the performance of different funds and select one that is best suitable for their needs. They can simply invest in ESS and let asset managers handle the selection of funds.
However, investors should remember to hold these funds for more than 12 months, as early redemption from the scheme comes with an exit load charge of 1%.