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What is an equity savings fund?

Equity savings fund is an open-ended mutual fund scheme that invests its assets in equity, arbitrage, debt opportunities. This is a new mutual fund category under the Hybrid Mutual Funds that were introduced by SEBI in its mutual fund recategorization in 2017. According to SEBI regulations, the fund should invest a minimum of 65% of assets in equity, and a minimum of 10% in debt securities.

Equity savings funds are considered safer than regular equity mutual funds and more tax efficient than the regular debt funds. This is because of their exposure to both equity and debt securities. Moreover, this helps the fund manager to manage the fund efficiently by switching between asset classes according to the market conditions and sentiments. This will help them contain losses and maintain the risk exposure of the fund at a moderate level.

Also, since the fund invests in arbitrage opportunities, the fund capitalizes on the price fluctuations in the market. The fund’s equity exposure helps in preventing the erosion of the investor’s purchasing power. At the same time, the debt and arbitrage portion help in minimizing the downside market fluctuations.

As the fund majorly invests in equity and arbitrage opportunities, it is much more tax efficient than debt funds if held for more than one year. Hence, returns equity savings fund are taxable like any other equity fund. The short-term capital gains (STCG) are taxable at 15%, and the long term capital gains (LTCG) exceeding INR 1 lakh are taxable at 10%. There is no tax on LTCG below INR 1 lakh.

Equity savings funds are a perfect investment option for conservative investors. These funds also suit investors who are looking for short term investment alternatives to debt mutual funds and fixed deposits.

How does an equity savings fund work?

Equity saving scheme is a hybrid mutual fund scheme that invests at least 65% of its assets in equity and 10% of its assets in debt securities. According to SEBI regulations, the fund can invest in equity and equity related instruments, debt securities, and arbitrage opportunities using hedging strategies.

The fund has exposure to equity and debt securities, making it a diversified fund and hence spreading the risk to more than one asset class. Moreover, the fund invests in arbitrage opportunities making it easier for the fund managers to switch between asset classes according to market sentiments. This will enable fund managers to manage the risk in an efficient manner.

Equity saving schemes can also invest in using hedged and unhedged strategies. The fund actively uses derivative strategies to manage the risk by investing through hedged strategies. At the same time, the fund also increases its return by investing in unhedged strategies. 

The fund offers better returns than fixed deposits in the short term as it invests in arbitrage opportunities. And the fund is tax efficient as the fund majorly invests in equities and follows the equity taxation rules.

Things to consider before investing

Following are certain factors that one should consider before investing in Equity Savings fund:

Quantitative Factors

Risk and Performance Analysis

Studying the risk factors will help in understanding the consistency in the performance of the fund across various market cycles. For example, considering the rolling returns over the short term and long term, and the risk-reward ratios such as Sharpe Ratio, Standard Deviation, etc. Investors can use mutual fund return calculators like SIP calculator and lumpsum return calculator to estimate their potential returns. Scripbox’s mutual fund return calculators are available online and are free to use. They help in estimating the potential SIP return and lumpsum return from mutual fund investments.

Performance across market cycles

It is vital to understand the fund’s ability to perform consistently across different market cycles. Therefore, comparing the performance of the fund with their benchmark index will help in understanding the deviation. It is important to compare the performance across both bull phase and bear phase.

Qualitative Factors

Portfolio

The quality of the fund’s portfolio plays an important role in the performance. Following are some factors that need to be considered while understanding the portfolio:

  • Diversification: A fund should offer adequate diversification to its investors. An overly concentrated portfolio will react drastically to market movement. Therefore, a well-diversified portfolio should have its top 10 holdings under 50%. This will ensure the market risk is spread across the portfolio.
  • Credit Quality: For the debt component of the fund holding, it is essential to observe the credit quality of the holdings. The fund mustn’t hold too many low rated securities (securities with rating AA or below) or unrated debt instruments. Ideally, a fund with good credit quality should be considered for investment.
  • Turnover Cost: Turnover cost indicates frequent buying and selling of securities. A higher turnover cost is bad as it lowers the portfolio returns for the investor. Therefore, it is good to choose funds with a not very high turnover ratio (expense ratio).

Fund House and Fund Management

The reputation of the fund house and the fund manager’s experience also plays an important role while choosing a fund to invest. The fund manager should have good industry and fund management experience. However, experience doesn’t just mean the number of years in the work. It also means that the funds they have managed in the past have been consistently performing well. 

The decisions a fund manager takes plays an important role in the fund’s ability to generate significant returns. Therefore, the decisions that the manager takes should be backed by thorough mutual fund research and analysis.

A fund house’s reputation is also important while choosing a fund to invest. The fund house should ideally be performing consistently across all the funds they offer. A fund house with schemes that perform well indicates the efficiency of their investment process and risk management techniques.

Who should invest in an equity savings fund?

Equity savings mutual funds best suit investors looking for equity exposure for a short term investment horizon. The ideal investment horizon for these funds is around 24-30 months. These funds have exposure to debt and arbitrage opportunities as well and hence making them less risky than pure equity funds. However, they come with an advantage of better returns than pure debt funds due to their equity exposure. Hence investors with low understanding of risk who want equity exposure can also invest in these funds.

Equity Savings Mutual Funds are a perfect substitute to fixed deposits as they offer higher returns with somewhat similar risk. Moreover, these funds are tax efficient than debt funds. These funds are taxed like other equity funds where the long term is any period after one year. Hence the tax rate for these funds is lower than debt funds. Hence investors looking for lower tax liability can invest in these funds.

Investors who are worried about  market volatility can invest in these funds. Additionally, investors who want to venture out from the conventional savings options like FDs and RDs can consider investing in an equity savings fund. However, it is important to note that mutual fund investments are subject to market risk. Hence, one should carefully align their investment objectives to their investment choices.

What are the fund categories under equity funds?

Equity mutual funds invest a minimum of 65% of their corpus in stocks or shares. Since equity funds invest in stocks, they come with a significant amount of risk associated with them. As a result, the returns are higher in comparison to other categories of mutual funds. Following are the categories under equity mutual funds:

  • Large Cap Fund (Bluechip fund)
  • Mid Cap Fund
  • Large and Mid Cap Fund
  • Small Cap Fund
  • Multi Cap Mutual Funds
  • Value Funds
  • Thematic / Sector Funds
  • Equity Linked Savings Scheme (ELSS – tax saver funds)
  • Focused Funds
  • Dividend Yield Funds
  • Index funds

To know more about mutual funds, types and how they work, read our guide.

What are the fund categories of debt funds?

Debt mutual funds invest a major portion of their corpus in fixed income or debt instruments. For example, debt mutual funds invest in fixed income instruments such as money market instruments, government securities, debentures, and corporate bonds. In comparison to equity mutual funds, debt funds are low-risk mutual fund investments. The fund manager strategies the asset allocation is a way that the portfolio comprises high-quality instruments. The following are the categories of debt mutual funds:

What are the different types of hybrid funds?

Hybrid mutual funds invest in both equity and debt securities. Best hybrid funds invest around 50%-70% in equity & equity related instruments and the remaining in fixed income instruments. Following are the different types of hybrid funds: