IIFL launches India’s first passive tax-saving fund after SEBI’s nod

IIFL Mutual Fund has launched the new fund offering of IIFL ELSS Nifty 50 Tax Saver Index Fund (IN50).

It is the first passively managed tax-saving scheme (also known as Equity-Linked Savings Scheme, or ELSS) to be launched after the capital market regulator, Securities and Exchange Board of India (SEBI), allowed fund houses to launch such passive funds on May 23, 2022. Should you invest in the scheme?

What is on offer?

IN50 is an equity fund. It will invest in all stocks in- and in the same proportion as they lie in- the Nifty50 index. It will aim to mimic Nifty 50 index’s returns. This also means IN50’s fund manager will not take cash calls; it won’t substantially hold cash, like some other tax saver schemes do.

Being a tax saver fund, all investments in this scheme up to Rs 1.5 lakh, along with other eligible contributions, will fetch you deduction under Section 80C of the Income Tax Act. Like all contributions to ELSS, the units of this scheme too will be locked in for three years from the date of allotment.

What works?

The big advantage of this scheme is there is no fund manager risk.

Harshvardhan Roongta, CEO of Roongta Securities, says: “This can be a preferred choice for investors who are keen on passive investing.” In actively managed ELSS funds, if the fund manager underperforms after your invest in them, you can move out only after completing three years. A passively managed scheme helps you reap index-linked returns and you need not worry about a fund manager’s performance, he adds.

When an investor makes peace with market returns, and does not go out searching for alpha, she can focus on her core financial objectives such as investing in equities and tax planning.

“Passive as a category is picking up steam and we believe that it is a very good option for retail investors who do not want to go into the exercise of analysing and studying different mutual fund schemes and fund managers. A passive scheme allows investors to simply think of their 80C investment as a split between FDs, PPFs, insurance, and ‘equity’ – without having to worry about deep analysis,” says Parijat Garg, a fund manager at IIFL Asset Management.

From a financial planning point of view, a large-cap passive ELSS makes sense, given that large-cap funds have been struggling to outperform their benchmark indices of late. Since these schemes come with a 3-year lock-in, you can invest in such large-cap funds, get the tax benefits as a bonus and expect market returns. For outperformance, you can then focus on a bunch of multi-cap, mid- and small- cap funds.

Large-cap exposure

Another advantage of this scheme comes in the form of well defined ‘large cap’ exposure. The scheme tracks the Nifty 50 index, which houses 50 large-cap stocks and hence works the best for the investors who are keen to invest only in such stocks.

Large-cap portfolios, generally, are relatively less volatile compared to mid-cap and small-cap portfolios. As of now, ELSS, on an average, allocated 21.8 percent and 6.4 percent to mid- and small- cap stocks, as of 31 October, 2022, according to Value Research.

Being a passively managed fund, expense ratio of IN50 will be lower as opposed to other ELSS schemes. As per SEBI regulations, passive funds should cap expenses should be capped at 1 percent of the net assets under management of the scheme.

What does not work?

Generally an ELSS investment is the first investment in mutual funds for many investors. The tax deduction incentive works.

What matters more, though, as investors go along, is the returns. Over the three and five years ended 1 December 2022, ELSS schemes, on average, gave 17.49 percent and 11.56 percent returns, respectively.

Over the same period, schemes tracking the Nifty 50 index, for example the UTI Nifty 50 Index Fund, gave 16.85 percent and 14.21 percent returns.
In case of a broad-based rally, something similar to which we saw post the Covid-19 pandemic lockdowns, the exposure to mid and small cap stocks can help earn better returns.

A large-cap-focused ELSS scheme such as IN50 tends to score lower in such circumstances. But this is a minor setback as funds perform in cycles; large-cap funds also tend to outperform broader markets in different market conditions.

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Abhay Mathure, a Mumbai-based mutual fund distributor, says, “If you want a low- cost index fund, then there are many good alternatives with a good track record of low expense and low tracking error. And if you are keen on tax saving and wealth creation, then actively managed funds with some exposure to mid- and small-cap stocks make sense. Very few investors would be keen on index investing and tax saving together.”

What should you do?

To set the record straight, IN50 is not India’s first passively managed ELSS scheme. That honor went to Franklin Templeton nearly two decades ago when it had a scheme called Franklin India Index Tax Fund. That scheme used to track the Nifty 50 index and offer Section 80 C tax deduction benefits, too.

The scheme was merged into the Franklin India NSE Nifty 50 Index Fund (FIIF) in September 2011. Some market observers recall this merger and say that a “lack of interest in passively managed products” compelled Franklin Templeton to merge it with FIIF.

Investing in ELSS help you achieve the twin objectives of tax saving as well as wealth creation over the long term. Even after the end of the lock-in period of three years, there is no compulsion to sell units of an ELSS.

Just to be sure, a fund house is allowed to launch either an actively managed or a passively managed ELSS under current guidelines. So do not expect other fund houses with an actively managed ELSS to launch a passively managed product.

Keep an eye out on this scheme’s tracking error. If you are keen on investing in the Nifty 50 only and want to avail tax benefit, then you may consider this scheme. Other investors can skip this scheme for time being.

The NFO closes on 21 December 2022.