Equity Saving Schemes

Equity savings schemes funds are mutual funds that invest at least 65% of their assets in equity shares of companies across different sectors and market capitalisations. They also invest up to 10-35% of their assets in debt instruments such as government securities, corporate bonds, money market instruments, etc. The remaining 5% of their assets can be invested in arbitrage opportunities such as futures and options contracts on stocks or indices.

The main objective of equity savings schemes funds is to provide investors with a combination of growth and income potential along with moderately high risk. In this article, you will learn about the equity savings schemes meaning, how equity savings schemes work, its features, advantages and more in detail.

What are equity savings schemes?

Equity savings schemes represent open-ended mutual fund schemes investing in equities, arbitrage, derivatives, and debt securities. These funds offer more consistent returns compared to other mutual fund schemes.

They allocate investments in equities, derivatives like arbitrage, and debt securities, aiming for 65% exposure in equities and a minimum of 10% in the debt asset class. This diversified portfolio enhances safety and offers returns surpassing those of fixed deposits. However, investors should anticipate moderate returns, typically ranging between 4-6%.

How do equity savings mutual funds work?

Equity savings mutual funds maintain diversified portfolios, serving various investor needs. They predominantly invest in stocks of different companies, adjusting asset allocation based on market conditions across small-cap, mid-cap, or large-cap stocks, while allocating the remainder to debt and other market instruments.

The arbitrage component within the portfolio mitigates downside risk while ensuring steady income from debt-related instruments. This balanced approach aims to provide stability and growth potential to investors over time.

What is the purpose of equity savings mutual funds?

• Mitigating risk: Equity savings mutual funds can help investors reduce the volatility and downside risk associated with investing directly in stocks. By diversifying across different asset classes and sectors, they can cushion the impact of market fluctuations and enhance returns over the long term.
• Capital appreciation: Equity savings mutual funds can help investors earn 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 and competitive advantages, they can benefit from capital appreciation over time.
• Diversification of funds: Equity savings mutual funds can help investors diversify their portfolio across different asset classes and sectors. This can help them reduce the overall risk and optimise returns by taking advantage of different opportunities in different markets.
• Income generation: Equity savings mutual funds can help investors generate regular income from dividends or interest payments by investing in debt instruments or arbitrage opportunities.
• Tax-efficiency: Categorised as equity funds, ESS offer tax-exempt capital gains up to Rs. 1 Lakh if held for over a year, promoting long-term wealth creation.
• Stable returns: The arbitrage component in ESS helps generate stable returns with lower volatility compared to pure equity investments, making them suitable for investors seeking a balance between growth and stability.

Who should invest in equity savings schemes?

• Investors seeking stock market exposure: Equity savings schemes can help investors gain exposure to the stock market without having to buy individual stocks or monitor them closely. By investing through a fund manager who selects stocks based on research and analysis, they can benefit from professional expertise and convenience.
• Investors seeking risk averse fund: Equity savings schemes can help investors reduce their risk appetite by investing in a balanced mix of equity, debt, and arbitrage instruments. By diversifying across different asset classes and sectors, they can minimise the impact of market fluctuations and enhance returns over time.
• Investors seeking an alternative to specific traditional options: Equity savings schemes can offer an alternative option to other traditional investment options such as fixed deposits or bonds that may not offer high returns. By investing through a fund manager who selects stocks based on research and analysis, they can benefit from professional expertise and convenience.

What are the features and benefits of equity savings schemes?

• Hybrid nature: Equity savings schemes have a hybrid nature that combines the benefits of both equity investments (growth potential) with debt investments (income generation). This helps them provide consistent returns along with capital protection.
• Risk management: Equity savings schemes have a risk management strategy that involves diversifying across different asset classes (equity), sectors (diversified), geographies (domestic), etc., as well as using hedging techniques such as futures contracts or options contracts on stocks or indices. This helps them reduce volatility and downside risk while enhancing upside potential.
• Diversification: Equity savings schemes have a diversification strategy that involves investing in quality companies with strong fundamentals across a variety of industries and markets, which opens up many opportunities for investors to grow their wealth.
• Reduced volatility: Over 50% investment in debt and arbitrage strategies helps these schemes offer more stable returns compared to pure equity funds. Fund managers use derivatives to further manage risk.
• Tax efficiency: Equity saving schemes are taxed as equity funds, offering tax benefits. Hold them for over a year and gain up to Rs. 1 lakh tax-free on long-term capital gains.
• Arbitrage for stability: The inclusion of arbitrage strategies helps exploit market inefficiencies, generating low-risk returns and contributing to overall stability of the fund.

Equity savings schemes – Taxation

• Long-term capital gains benefit: Gains below Rs. 1 lakh from these funds are tax-free if held for over 1 year. Gains above Rs. 1 lakh are taxed at 10%.
• Short-term capital gains tax: Gains from these funds are taxed at 15% if held for less than 1 year.

Read more about, What is short-term capital gain tax.

Factors to consider before investing in equity savings schemes

• Investment objectives: You should have a clear idea of why you are investing in equity savings schemes and what are your financial goals. For example, are you investing for retirement, wealth creation, or income generation? Your investment objectives will help you determine your risk appetite, time horizon, and asset allocation.
• Risk tolerance: You should assess your risk tolerance level and how comfortable you are with taking risks. Equity savings schemes are suitable for investors who have a high risk tolerance and can withstand market fluctuations. However, they are not suitable for investors who have a low risk tolerance.
• Exit load: You should check the exit load of the equity savings scheme before investing. An exit load is a fee charged by the fund house when you redeem your units within a specified period. It can range from 0.5% to 2% depending on the scheme and the duration of redemption. You should avoid investing in schemes that have high exit loads as they can erode your returns.
• Performance: You should compare the performance of different equity savings schemes based on their past returns, consistency, volatility, and benchmark performance. You should also look at the fund manager’s experience, investment style, and track record. You should invest in mutual fund schemes that have consistently outperformed their peers and benchmarks over a long period of time.

Disadvantages of investing in equity savings schemes

• Interest rate risk: Equity savings schemes are exposed to interest rate risk as they invest in debt instruments that have variable interest rates. If interest rates rise, the value of these debt instruments falls and vice versa. This can affect the returns of equity savings schemes as they depend on both income from debt instruments and capital appreciation from equity shares.
• Inflation risk: Equity savings schemes are exposed to inflation risk as they invest in assets that lose their purchasing power over time due to inflation. Inflation reduces the real returns of equity savings schemes as they cannot beat inflation by increasing their prices.
• Lack of control: Equity savings schemes do not give you full control over your investments as you cannot choose which stocks or sectors to invest in or when to buy or sell them. You have to rely on the fund manager’s decisions and follow their investment strategy.

Conclusion

Equity savings schemes may help investors achieve their financial goals by generating regular income from dividends or interest payments along with capital appreciation from stock price movements. However, they also have some risks such as interest rate risk, inflation risk, lack of control, etc., that investors should be aware of before investing.

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