Equity Saving Schemes: A Guide To Investing Wisely

Equity savings funds are a type of mutual fund that invests in a mix of stocks, bonds, derivatives, and arbitrage. They are considered to be safer than pure equity funds and more tax-efficient than pure debt funds. These funds are perfect for conservative investors who want to earn high returns without taking on too much risk. When considering an equity savings fund, it is important to examine the risk factors, performance across market cycles, and the quality of the fund's portfolio. Additionally, the reputation of the fund house and the experience of the fund manager are also key factors in choosing a fund.

Understand the features of an equity savings scheme

Equity savings schemes (ESS) are a type of mutual fund that invests in a mix of stocks, bonds, and arbitrage opportunities. They are considered a relatively low-risk product, making them suitable for risk-averse investors. Here are some key features of ESS:

• Risk and Returns: ESS invests in both stock and debt, making them less risky than pure equity funds. However, returns may fluctuate with market changes as the performance of the underlying instruments affects the Net Asset Value (NAV) of the funds. They are known for providing consistent returns over the long term.
• Investment Pattern: ESS typically invests 30-35% of its total corpus in equity assets, while the rest is invested in debt income funds and arbitrage. This diversification helps neutralise volatility related to the stock market to a certain extent.
• Taxation: ESS is treated as equity funds for taxation purposes. If investors hold the funds for over 12 months, returns up to Rs. 1 Lakh are exempt from taxation. However, if gains are redeemed before one year, they are taxed at 15%.
• Arbitrage Advantage: The arbitrage portion of ESS allows fund managers to capitalise on pricing inefficiencies in the cash and derivatives segments of the equity market. This feature provides downside protection and stable returns.
• Portfolio Diversification: ESS offers a diverse investment portfolio through a single investment channel, eliminating the need for investors to analyse the performance of different funds.
• Suitability: ESS is ideal for conservative investors who want to avoid market volatility and those transitioning from traditional savings options like fixed deposits to capital market-linked investments. These schemes also suit individuals with a short-term investment horizon of around 18-24 months.

Compare with other tax-saving instruments

Equity savings funds are considered safer than regular equity mutual funds and more tax-efficient than regular debt funds. This is due to their exposure to both equity and debt securities. The fund manager can efficiently switch between asset classes according to market conditions, containing losses and maintaining moderate risk exposure.

Compared to other tax-saving instruments, equity savings funds have the potential to offer better returns, as they invest in equities with strong potential for good returns, which can beat inflation. They also have the shortest lock-in period of 3 years compared to other schemes.

| | Public Provident Fund (PPF) | National Savings Certificate (NSC) | 5-Year Tax-Saving Fixed Deposits | National Pension System (NPS) | Mutual Fund (Equity) |

| --- | --- | --- | --- | --- | --- |

| Tax Deduction Limit (Section 80C) | | | | | |

| Returns | 7.1% | 7.7% | | | 15% |

| Lock-in Period | 5 years | | 5 years | 60 years | 3 years |

Equity savings funds are a perfect substitute for fixed deposits, offering higher returns with similar risk. They are also more tax-efficient than debt funds due to their equity exposure.

These funds are ideal for investors seeking equity exposure for a short-term investment horizon of around 24-30 months. They are suitable for conservative investors who want to venture out from conventional savings options like FDs and RDs, as they offer better returns with moderate risk.

Additionally, equity savings funds are treated as equity schemes for taxation purposes, resulting in favourable taxation. If investors hold the funds for over a year, returns up to Rs. 1 lakh are exempt from taxation.

Weigh up the risks and returns

Equity Saving Schemes (ESS) are a relatively new financial vehicle in the Indian market. They are open-ended mutual fund schemes that invest in a mix of stocks, debt, and arbitrage opportunities. ESS is considered safer than pure equity funds and more tax-efficient than pure debt funds.

Risk Management

ESS has a risk management strategy that involves diversifying across different asset classes, sectors, and geographies, as well as using hedging techniques such as futures or options contracts. This helps reduce volatility and downside risk while enhancing upside potential. ESS typically invests 30-35% of its corpus in equities, with the rest in debt and arbitrage. This diversification strategy helps to provide consistent returns and protect capital.

Taxation Benefits

ESS is treated as equity funds for taxation purposes, offering tax benefits. Long-term capital gains (held for over a year) of up to Rs. 1 lakh are tax-free, while gains above Rs. 1 lakh are taxed at 10%. Short-term capital gains (held for less than a year) are taxed at 15%. The favourable taxation makes ESS attractive to investors concerned about tax efficiency.

Stable Returns

The arbitrage component in ESS helps generate stable returns with lower volatility compared to pure equity investments. The fixed income and arbitrage portions of ESS provide a cushion against sharp market falls, minimising potential losses. ESS is, therefore, a good option for investors seeking stable returns and a balance between growth and stability.

Capital Appreciation

ESS can provide higher returns than fixed deposits or other traditional investment options by participating in the growth potential of the stock market. By investing in quality companies with strong fundamentals, ESS can offer capital appreciation over time. ESS is suitable for investors seeking stock market exposure without the need to buy and closely monitor individual stocks.

Diversification of Funds

ESS can help investors diversify their portfolios across different asset classes and sectors, reducing overall risk and optimising returns by taking advantage of different market opportunities. ESS offers a diverse investment portfolio through a single investment channel, eliminating the need for investors to analyse the performance of different funds.

Suitability

ESS is suitable for conservative investors who are averse to high risk and volatility. It is also a good option for first-time investors moving from traditional savings options to capital market-linked investments. ESS is recommended for those with an investment horizon of at least 12-24 months.

Know who should invest in an equity savings fund

Who Should Invest in an Equity Savings Fund?

Equity savings funds are ideal for investors seeking equity exposure over a short-term investment horizon. The ideal investment horizon for these funds is around 24-30 months. They are also suitable for investors who are looking for short-term investment alternatives to debt mutual funds and fixed deposits.

Equity savings funds are a good option for conservative investors who do not have a high-risk appetite and want equity exposure. They are also suitable for investors who are worried about market volatility and are looking to venture out from conventional savings options like FDs and RDs.

Additionally, these funds are perfect for investors who want to gain capital to fulfil short-term goals in the near future. They are also a good option for first-time investors who are moving from traditional forms of investments such as bank fixed deposits to capital market-related investments.

Factors to Consider Before Investing in Equity Savings Funds

• Risk and Performance Analysis: It is important to study the risk factors to understand the consistency of the fund's performance across various market cycles. Investors can use mutual fund return calculators to estimate their potential returns.
• Performance across Market Cycles: It is crucial to compare the performance of the fund with its benchmark index to understand how it deviates during both the bull and bear phases.
• Diversification: A well-diversified portfolio should have its top 10 holdings under 50% to ensure the market risk is spread across the portfolio.
• Credit Quality: For the debt component of the fund, it is important to consider the credit quality of the holdings. The fund should not hold too many low-rated securities or unrated debt instruments.
• Turnover Cost: A higher turnover cost can lower portfolio returns, so it is advisable to choose funds with a moderate or low turnover ratio.
• Fund House and Fund Management: The reputation of the fund house and the experience of the fund manager are also important considerations. The fund manager should have good industry experience, and the funds they have managed in the past should have performed consistently well.

Learn how to invest

Equity savings funds are a type of open-ended mutual fund that falls under the SEBI's Hybrid category. They invest in a mix of stocks, bonds, derivatives, and arbitrage, aiming to provide better returns than pure equity or debt funds with reduced volatility. Here are the steps to help you get started with investing in equity savings schemes:

Step 1: Understand your Investor Profile

Before investing, it is essential to assess your risk tolerance, investment goals, and time horizon. Equity savings schemes are suitable for conservative investors seeking lower risk and consistent returns. These funds are ideal for short-term investment horizons, typically ranging from 12 to 24 months or more.

Step 2: Research and Compare Different Funds

When choosing an equity savings fund, it is crucial to conduct thorough research and comparisons. Consider factors such as the fund's performance across different market cycles, the diversification of its portfolio, credit quality of debt holdings, and the turnover cost. Compare the risk and reward ratios, such as the Sharpe Ratio and Standard Deviation, to gauge the fund's consistency. Additionally, evaluate the reputation and experience of the fund house and fund manager.

Step 3: Choose a Reputable Platform

Select a reliable platform to invest in equity savings schemes. You can choose to invest through the Asset Management Company (AMC) or online platforms like Groww, which offer paperless sign-up and expert recommendations.

Step 4: Complete the KYC Process and Registration

Before investing, you will need to complete the Know Your Customer (KYC) process, which may include providing your PAN card, bank details, and other relevant documents. Follow the platform's instructions to register and create your investment account.

Step 5: Decide on the Investment Mode and Amount

Equity savings schemes offer flexibility in terms of investment modes. You can choose between Systematic Investment Plans (SIPs), where you invest a regular amount at fixed intervals, or lumpsum investments, where you invest a large sum at once. Consider your financial situation and goals when deciding on the mode and amount to invest.

Step 6: Monitor and Review your Investments

After investing, remember to regularly monitor the performance of your chosen equity savings scheme. Review the fund's performance at regular intervals to ensure it aligns with your investment goals and risk tolerance. Stay updated with market trends and seek expert advice if needed to make informed decisions.

By following these steps, you can begin your journey towards investing in equity savings schemes. Remember to conduct thorough research, assess your risk profile, and make informed decisions based on your investment goals.

Frequently asked questions