ESFs: Ideal for investors seeking FD-plus returns, low volatility

Market volatility has made equity allocation difficult, especially for conservative investors. Equity Savings Funds (ESFs) offer a solution to this problem. A recent new fund offer (NFO) of an ESF from WhiteOak Capital Asset Management Company (AMC) highlights their growing appeal.

 

“ESFs offer a blend of equity, debt, and arbitrage with lower volatility than pure equity funds, which is appealing amid recent market swings. They also deliver tax-efficient returns,” says Harshad Borawake, head of research and fund manager, Mirae Asset Investment Managers (India).

 

As of January 31, 2025, ESFs managed assets worth ₹42,161 crore, according to the Association of Mutual Funds in India.

 

How ESFs work

 

ESFs allocate up to 65 per cent of assets across stocks and arbitrage. Typically, 15-35 per cent is invested in stocks, and the rest in spot-future arbitrage and bonds. Though fund managers have flexibility in stock and bond selection, portfolios usually comprise large-cap stocks and high-quality bonds, besides government securities.

 

ESFs are classified as equity-oriented for tax purposes, with gains above ₹1.25 lakh on units sold after a year taxed at 12.5 per cent.

 

Manage volatility

 

ESFs are less volatile owing to their diversified mix. “These funds are relatively less volatile compared to pure equity schemes as they invest only a portion of their portfolio in unhedged equity and the rest in stable asset classes like debt and arbitrage, which together form a large part of the portfolio,” says Ramesh Mantri, chief investment officer, WhiteOak Capital AMC.

 

Diversification mitigates risk. “The diversification across these asset classes, which often exhibit low correlation with each other, aims to enhance the potential for superior risk-adjusted return over the medium to long term compared to investing solely in individual asset classes,” adds Mantri. 

 

Alternative to debt

 

ESFs can outperform fixed deposits over three- and five-year horizons. “ESFs, with the ability to offer moderate and tax-efficient returns with tolerable levels of volatility, serve as a good alternative to debt-oriented mutual funds or traditional fixed-income instruments,” says Mantri.

 

Long-term capital to be parked in fixed income can be put into ESFs. “They can be considered as a stable investment option during periods of market uncertainty while still capturing some upside from marginal equity exposure,” says Renjith Sivaram, equity fund manager, Mahindra Manulife Mutual Fund.

 

Risks to consider

 

ESFs are not entirely risk-free. “Market-related uncertainties and volatility can impact their near-term returns,” says Sivaram. Short-term losses are possible due to equity exposure. Over the month ended March 5, ESFs have lost 2.04 per cent on average.

 

All the asset classes carry their own risks. “Risks stem from equity market fluctuations impacting returns and arbitrage opportunities drying up during phases of low volatility. The debt portion faces interest rate sensitivity, a factor in today’s environment. Credit risk in debt instruments is also a factor to watch, so we only stick to government and high-quality corporate bonds,” says Borawake.

 

Investors must be prepared for long-term returns being lower than from pure equity funds.

 

For conservative investors

 

ESFs suit conservative investors looking for moderate equity exposure. “Conservative investors seeking reasonable, tax-efficient returns with lower volatility may find these funds suitable for allocating a significant portion of their surplus capital,” says Mantri.

 

Before investing, investors should assess asset allocation and check the portfolio construction. They must enter with a minimum three-year horizon. “Volatility can lead to periods of lower returns than fixed-income investments. Therefore, ESFs are best suited for investors with a longer investment horizon,” says Sivaram.