In an economy awash with liquidity, low interest rates are an obvious outcome. While borrowers celebrate, individuals depending on their savings for regular income – especially senior citizens - are the worst hit. As interest income falls and gold and real estate do not offer much, they are forced to consider investments in stocks. However, the volatile stock markets are no easy bite for risk-averse first-time investors. In such a dilemma equity savings fund appear to be a worthy investment option.
“Equity saving funds invest up to 35 percent money in stocks and can offer better returns than fixed income alternatives. As these schemes enjoy taxation of equity funds, they make investment sense with a minimum two year-time frame,” advises Vijai Mantri, chief mentor and co-founder of BuckFast Investment Advisory Services.
Equity saving funds
For the uninitiated these are mutual fund schemes that invest in a mix of stocks, arbitrage and bonds. Typically, the fund invests 30-40 percent of the money in stocks. Around 30 percent of the money is invested in arbitrage positions and rest in bonds. The fund manager ensures that minimum 65 percent of the money is invested in stocks and arbitrage put together. The arbitrage trade involves buying a stock in cash market and selling the same stock in futures market simultaneously. This is a market neutral trade. Put simply, there is no stock market risk and the fund manager is keen to capture the price differential, thereby ends up pocketing money market returns.
“As 65 percent of the money is technically invested in stocks, the fund gets to enjoy tax treatment of equity fund,” points out Gajendra Kothari, managing director & CEO of Etica Wealth Management. However, the net exposure to stocks remains around 35 percent. This keeps the volatility low. Given the equity taxation, all dividends declared by these schemes are tax-free and all capital gains earned on investments held for more than one year are tax-free, Kothari adds.
What to expect?
As these funds invest money in stocks, one should expect higher returns as compared to fixed deposits and bond funds. Bond funds attract long term capital gains tax at the rate of 20 percent post indexation if held for three years and interest on fixed deposits is taxed at marginal rate of tax. Given the tax-free status of long-term capital gains on equity savings funds, your post tax returns can be much higher.
But these funds should offer returns less than balanced funds and equity funds, given relatively lower exposure to stocks. Many times, investors end up buying top-of-the-chart equity funds to maximize returns, but end up with a shock when the volatility comes back to Dalal Street.
Investors in these funds should see low volatility as compared to diversified equity funds and balanced funds. As it is a relatively new category of funds, there is not much to look at past record. A look at the table will give you an idea of how they have performed in recent past.
How to go about it?
“Markets are not cheap any more. The best way to invest in these schemes is through a systematic investment plan. If you have lump sum money on hand, park it in liquid fund. Then, sign up for a systematic transfer plan and instruct the fund house to systematically transfer the money into equity saving fund,” says Gajendra Kothari. This will ensure that you do not become a victim of timing risk.
Some of these schemes and some balanced funds are offering a monthly dividend option. The frequency and the quantum of such dividend are not at all guaranteed in nature. “Do not count on these schemes’ dividends for regular income. If you are keen on regular income go for systematic withdrawal plan,” advises Vijai Mantri. You can invest in these funds’ growth option and after a year you can initiate tax-free regular income by way of systematic withdrawal plan. The regular income lasts for a time period determined by factors such as the quantum of money you withdraw each month and the returns generated by the scheme.Equity savings funds stand between the less conservative options such as balanced funds, diversified equity funds and the more conservative options such as MF monthly income plans. They can be tapped by first-time investors seeking investments in stocks.