Equity saving funds best for investors to lower risk

ESFs have a tad lower net equity compared to the balanced advantage funds. This reduced equity plays well for conservative investors and those with lower time frames.

When investing we mostly consider the returns generated from it, often ignoring or discounting the risks associated with it. One should always remember that each investment option serves a purpose and not one avenue serves all needs. So, one should be aware of the difference each instrument offers and use appropriately to their advantage.

There are different choices within the hybrid mutual funds and as a sub-category of equity hybrid funds per the taxation laws. Balanced advantage funds which are categorised under the dynamic asset allocation funds as per the regulator have been in existence for a very long time.

As the name suggests, the allocation towards various assets is fluid and opportunistic. The fund maintains a gross majority of equity allocation of 65 per cent or more through exposure to arbitrage and derivatives, to ensure the tax advantage. The use of derivatives i.e., futures & options is to hedge or offset the risk of the portfolio while investing the rest in debt securities.

These funds achieve capital appreciation through equity allocation while simultaneously generating consistent income from their debt portfolios and trying to limit the losses from the market volatility through their derivative exposure. This dynamism helps the fund suitable for all market conditions and trying to gain the best of both worlds of equity and debt.

Though operating on the same plank, equity savings fund (ESF) offers same option for a lower risk investor. The investment mix of equity, debt, arbitrage and derivates seem like that of the dynamic asset allocation funds, but they differ in the net equity exposure. These funds have a tad lower net equity compared to the balanced advantage funds. This reduced equity plays well for conservative investors and those with lower time frames. But as the gross equity remains majority (i.e., over 65 per cent) they do enjoy the beneficial taxation in both the long- and short-term.

The current capital gains taxation is skewed towards the equity investor with short-term taxation at 15 per cent versus the slab level for debt and the long-term at 10 per cent versus the considering as income to be taxed accordingly or 20 per cent with indexation. This tax arbitrage is what plays in favor of equity savings funds for those conservative investors trying to obtain a better risk adjusted return.

Considering the aggregated data in the last five years, the pure equity exposure of the category average of the balanced advantage funds (BAF) ranged from 37 to 72 per cent while that of the equity savings funds remained at about 40 per cent. This has allowed the equity savings schemes to provide a much consistent return to the unitholders at much lower volatility. This translated to higher median returns for the BAF though they did underperform the ESF during the overall market dips. The lower equity exposure contained the losses while the other aspects of the fund helped them to recover quickly, though can’t match the BAF returns during the bull phases of the market due to their lower equity exposure.

The equity presence of decent equity exposure along with the tax benefits provides better than debt returns providing a compelling case for exposure even for conservative investors. Most of the equity savings funds also come with zero exit loads making them ideal to park for even shorter periods of time. However, the equity exposure could upset in case of drastic equity market drawdowns. Hence, an investor with medium-term horizon could use if not alternatively but complement their conservative equity hybrids with ESF to create a robust portfolio. As mentioned at the beginning, this isn’t a remedy to all troubles for those conservative investors hunting for higher returns. But certainly they are persuasive and can’t be ignored in their presence in the portfolios to not just earn a higher return but also provide tax efficiency.

The author is a co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected]