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Equity savings funds are hybrid mutual fund schemes suitable for investors with moderate risk appetites. Risk in these funds is lower than aggressive hybrid funds like balanced funds, at the same time these funds enjoy equity taxation like balanced funds. Long term capital gains (holding period of more than 12 months) in equity savings funds are tax-free; short term capital gains (holding less than 12 months) are taxed at 15%. Dividends paid by equity savings funds are tax-free.

The overall exposure to equity in equity savings funds ranges from 65% to 90%. Mutual fund schemes which have more than 65% equity allocation enjoy equity taxation; long term capital gains (investing holding period of more than 1 year) and dividends are tax-free. However, a portion of the equity exposure is hedged and this reduces the risk of these funds considerably. The active (un-hedged) equity allocation of equity savings funds ranges between 20 to 30% with the objective of capital appreciation.

40 to 70% of the portfolio of equity savings funds is allocated to completely hedged equity positions to generate arbitrage or risk-free profits. 10 to 35% of the portfolio is invested in fixed income and money market instruments to generate income. Therefore, 70 to 80% of the portfolio has low volatility and generates regular income. Over a sufficiently long investment horizon, the active equity allocation can also generate capital appreciation for investors.

Investment Strategy and how does it work?

  • Arbitrage
  • Arbitrage by definition is defined as risk-free profit, by exploiting pricing mismatches in the market. Capital safety returns and liquidity are important considerations in the arbitrage strategy. In volatile market conditions arbitrage can generate comparable or even higher returns than liquid funds. For the arbitrage portion of the fund portfolio, the managers of equity savings funds take completely hedged positions to minimize any risk for the investor and generate arbitrage returns.

  • Fixed Income and Money Market
  • In the fixed income/money market portfolio within the overall scheme portfolio of equity savings, the fund managers usually employ an accrual strategy to generate income and minimize interest rate risk. Fund managers of equity savings funds usually prefer high-quality papers of credit. The fixed-income portfolio of equity savings funds, therefore, has a low-interest rate and credit risk and generates stable returns.

  • Active Equity
  • Equity savings funds take active (un-hedged) exposure within specified allocation ranges. When fund managers are bullish on equities they increase active (un-hedged) equity exposure to the upper end of the range. The fund manager, however, has the flexibility to reduce the equity allocations and increase exposures to safer options (like arbitrage or fixed income), if volatility increases in the stock market. This investment strategy ensures moderately low volatility for investors.

Why Equity Mutual Funds?

The main advantage of equity savings funds is low volatility and income. Risk and return are directly related; the higher the return, the higher is the risk. If you are looking for very high returns then equity savings funds are not for you. However, if your primary investment objectives are, low volatility, high liquidity, inflation-beating returns (through limited equity exposure), and tax efficiency, then Equity Savings Fund can be a good investment option for you.

Features of Equity mutual funds:

Here are some of the features of Equity Mutual Funds in India:

Lower Expense Ratio

Regular purchases and sales of shares in an Equity Fund can contribute to an increase in the expense ratio of the scheme. An upper limit for the expense ratio of equity funds at 2.5% has been set by the Securities and Exchanges Board of India (SEBI). It could also be further reduced by SEBI. For investors, this suggests more returns.

Tax Exemption under Section 80C

Tax exemption under Section 80C of the Income Tax Act with equity exposure is provided by the Equity Related Savings Scheme or ELSS. It has a short 3 year lock-in duration and provides tremendous potential for good returns to be won. You may also invest in instalments in an ELSS.

Portfolio Diversification

By investing a small sum, Equity Funds allow you to gain exposure to many good shares of equity. Your stock portfolio is thus diversified and has a greater chance of achieving good returns.

How to invest in Equity Mutual Funds?

As any other investment decision, before signing the dotted line, you must carefully determine your financial objectives, risk tolerance, and investment horizon. We have split investors into two large groups for the sake of understanding: new entrants and experienced investors.

If you are investing in Equity Funds for the first time…

Many new investors are wary of investing in the stock market because they are low-capital investors (young investors) or lack the time to track their investments continuously (share investments must be made) or lack the expertise to select the right shares. They are therefore moving to equity mutual funds. There are, however, many kinds of equity funds available and it can still be a struggle to choose the right one. To opt for Large-Cap Equity Funds, we suggest most new investors. These schemes usually invest in the shares of the best companies on the market and have a history of consistent returns being produced.

If you're a seasoned investor...

Nothing else we can tell that you don't already know is there! We advise you, however, to opt for diversified equity funds and take measured risks. As opposed to other equity funds, your knowledge of the market will help you pick the right scheme and earn better returns.

People Often Ask

  1. What is equity mutual fund?
  2. Equity savings funds are hybrid mutual fund schemes suitable for investors with moderate risk appetites. Risk in these funds is lower than aggressive hybrid funds like balanced funds, at the same time these funds enjoy equity taxation like balanced funds.

  3. How does equity mutual funds work?
  4. Equity mutual funds can function in multiple ways like Arbitrage, Fixed Income and Money Market and Active Equity.

  5. Which equity mutual fund is best?
  6. Some of the best equity mutual funds are-

  7. Are equity mutual funds safe?
  8. Yes, equity mutual funds are completely safe and it is affected by some market fluctuations, but overall equity mutual funds are safe.

Conclusion

Equity funds are commonly considered to yield around 10-12 percent returns (pre-tax). This is an average figure and, depending on the market conditions, the performance of any fund will vary. To help you ensure good returns on your investment, choosing the right scheme goes a long way. Here are few equity funds which have been the best performers, based on the returns of the past five years: