Passive ELSS Funds: A New Option, But Not Many Choices
While there might be a new variety of ELSS funds in the form of a passive fund, investors might not have many choices.
Equity linked savings schemes are one of the most popular mutual funds because they offer investors an opportunity to save on tax. Contributions to ELSS funds are deductible from taxable income under Section 80C, up to a total limit of Rs 1.5 lakh.
As a result, investors pay close attention to this category, especially during the last few months of the financial year. This financial year too, investors who have not yet been able to complete their tax saving investments have these funds as one of the possible options.
While there might be a new variety of ELSS funds, in the form of a passive fund, investors might not have many choices. That’s because of a technical detail in the regulations that were introduced by the Securities and Exchange Board of India.
Active Fund Management
The process of active fund management means that fund managers select stocks based on their judgement.
The category of ELSS funds is considered to be an important category for active fund managers because this allows them a lock-in of three years. It enables the fund manager to select stocks that can be held for the long term. This is often said to be one of the key factors that can increase the wealth creation over a longer period of time.
But, in reality, there is not much difference that can be seen in terms of the portfolio of an ELSS fund as compared to other diversified equity-oriented funds.
SEBI has made a regulatory change, which allowed the entry of passive funds into the ELSS category.
However, there is one point in the guidelines, which might restrict the number of passive ELSS funds. SEBI said that a fund house can have just one scheme in a particular category. In addition, they can have either an active fund or a passive fund in the ELSS category.
Most fund houses already have actively managed ELSS funds and so, can’t launch a passive option. That is, unless they first close the active fund.
This does not mean that there will not be any passive fund launches. New fund houses, who do not have an ELSS fund, can choose to launch a passive ELSS fund. That’s also true for existing fund houses that don’t currently have an ELSS fund.
The final decision would involve many parameters because a new fund house might still decide to go in for an active fund for this category because they believe that they will be able to generate alpha for their investors.
There is an offering by IIFL Mutual Fund that has been launched and this will track the Nifty 50 Index. As things stand, this will be the only option for investors in passive ELSS funds.
The risk that an investor faces in an ELSS fund is that equity will not perform during the three-year lock-in or that it might not be a good time for the equity markets when their lock-in ends. However, they have the option of holding on to their fund post expiration of lock-in.
Around 70% of the exposure of existing ELSS funds is in large-cap stocks, so these funds are large-cap heavy. A passive ELSS fund would at least assure no underperformance, though the overall market trends will not take care of the inherent risk of the investment.
Another factor to bear in mind is the expense ratio. Passive funds usually have a much lower expense than actively managed funds.
Arnav Pandya is founder of Moneyeduschool.