For investors with low-risk profile

Equity savings funds give additional tax benefit, as they are treated like equity funds

If the high volatility and year-to-date negative returns (around five per cent) from the equity markets are worrying you, consider investing in a class of funds called equity savings funds (sometimes also called equity-income funds). Recently, DSP BlackRock Investment Managers launched a new fund offer (NFO), which closes on Tuesday, for a fund belonging to this category.

Equity savings funds are hybrid funds that invest in equities, arbitrage opportunities and debt. Says Anup Maheshwari, head of equities and corporate strategy at DSP: “Most of the time, we will be in equities to the extent of 25 per cent, with the option to go up to 40 per cent, 35 per cent in debt and the balance 40 per cent in arbitrage.”

Mutual fund houses started launching equity savings funds aggressively after the government changed the tax treatment of debt funds in Budget 2014, allowing them long-term capital gains treatment after three years instead of one.

Due to this, low-risk products with a small exposure to equities like monthly income plans started getting unfavourable tax treatment. This product aims to provide a similar level of low risk, but gets a more favourable tax treatment. “This is a product for low-risk investors. It will offer the stability that comes from both debt and arbitrage, while some kicker to returns will come from equities. The biggest advantage comes from its treatment as an equity fund,” says Maheshwari.

The equity and arbitrage portion together have an allocation of around 65 per cent in these funds and hence, they become eligible for equity-like tax treatment. Says Vidya Bala, head of research at Fundsindia.com, “If you consider the risk-return profile of these funds, they lie between a monthly income plan (MIP) and a balanced fund.”

These funds are managed conservatively. “On the equity side, we shall have a 70-75 per cent allocation to large-cap stocks and 25-30 per cent to mid- and small-cap stocks. On the debt side, we shall avoid credit risk, but take some duration risk,” says Maheshwari.

According to Bala, one should have an investment horizon of at least two-three years in these funds, although an investment over one year makes one eligible for zero tax on long-term capital gains, because of the presence of the unhedged equity component.

In a falling market, you can expect these funds to contain downside risk much better than pure-equity funds, but they will not be able to ensure positive returns in such conditions due to the presence of the equity component.

Investors keen to create wealth and having an investment horizon of five years or more should avoid these funds. “Over the long term, equity savings funds will not be able to match the returns from equity funds,” says Bala.

Eleven players have launched equity savings funds so far. They have offered returns of 7.12-10.36 per cent over the trailing three years. Before picking a fund from this category, check the portion of the portfolio invested in unhedged equities: the higher this portion, higher the risk. As for DSP BlackRock’s NFO, wait for some time until the fund has created a track record.