Equity income funds good for conservatives

Since debt component and arbitrage portions contain equity risk, first-time or retired investors can feel safe

When tax laws change, fund houses are quick to respond with products more conducive to the new guidelines. After the 2014-15 Union Budget, when short-term tax treatment of debt funds were changed, fund houses were quick to push arbitrage funds which are treated as equity funds.

Similarly, many have launched a slew of new schemes in a particular category – equity income funds. These schemes invest more than 65 per cent of the money in equities – for equities tax treatment – and the rest in debt or cash. For example, Birla SunLife Equity Savings Fund and Kotak Equity Savings Fund have 76.04 per cent and 66.84 per cent in equity, respectively. And, fund houses have been successful in raising money through these. Just 10 mutual fund schemes have garnered almost Rs 4,000 crore as of September.

Nilesh Shah, MD, Kotak Mutual Fund, says, “This is a scheme in which 25 per cent is in pure equity and 40 per cent in arbitrage. So, the investor is quite protected if the equity market falls sharply. These schemes are meant to attract first-time or retired investors who are unsure of the equity market. Once, they see good returns for a few years, they can graduate to equity funds with more confidence.”

Sunil Singhania, chief investment officer (equities), Reliance Mutual Fund, adds, “These schemes have low volatility. And it is recommended for investors who want to build their wealth over the long time...till you need the money. Usually for equity funds, we say three years is a good time but the mix of instruments in this scheme makes it a good savings product.” The portfolio of Reliance Equity Savings Fund has 40 per cent active equity, another 30 per cent in arbitrage (passive equity) and the rest in debt. According to Singhania, the active portion of equity has 70 per cent in large cap stocks and rest 30 per cent in mid-cap stocks.

As these schemes have many constituents, it is difficult to track their performance vis-a- vis any one parameter. For example, a fund that has 25 per cent in active equity, 40 per cent in arbitrage (passive equity) and another 30-35 per cent in debt will be benchmarked against various indices. That is, one scheme has three benchmarks – CRISIL Liquid, S&P BSE 200 and CRISIL Short-term Bond (30) indices. So, it is difficult to say whether it has out or underperformed any index if an individual investor were to try and do it.

But the biggest advantage is that they are tax-efficient because of the high equity component. So, there is a short-term capital gains tax of 15 per cent and zero long-term capital gains tax. This makes them better than debt funds or fixed deposits as the returns or interest income is taxed, as per the tenure and tax laws. Interest income of fixed deposits are added to your income and taxed, according to the income-tax bracket.

For debt funds, the definition of long-term capital gains was changed from one year to three years. If redeemed before three years, the gains will be added to your income and taxed like a fixed deposit. However, if you stay invested for three years, the tax rate will be 20 per cent after indexation. While majority of the schemes in this category are new, the returns are quite decent (see table). This is a good investment initiation into equities for the risk-averse.