Are Equity Savings Funds a Worthwhile Option to Earn Better Returns Than Bank FDs?

Several global and domestic headwinds in play are likely to keep the market volatile in the near term, including geopolitical tensions, U.S. President Donald Trump's tariff tantrums, a weakening rupee against the greenback, a slowdown in corporate earnings of India Inc., and relentless FPI selling.

Against this backdrop, it is natural for investors to feel nervous and be inclined towards lower-risk investment options that still have the potential to earn safe returns.

Bank Fixed Deposits (FDs) are perceived to offer secure non-market linked returns. During the interest rate upcycle from May 2022 and February 2023, when the Reserve Bank of India (RBI) cumulatively increased the policy repo rate by 250 basis points (bps), many banks were promoted to increase their deposit rates, thus largely benefitting depositors.

Thereafter, until December 2024 the RBI maintained the repo rate at 6.50%, which was a stable interest rate regime for depositors.

However, in its February 2025 bi-monthly monetary policy meeting, the RBI announced a 25 bps rate cut, bringing the policy repo rate down to 6.25%. One of the primary reasons behind this decision was easing CPI inflation (also known as retail inflation), which declined from its peak of 6.21% in October 2024 to 4.31% in January 2025.

Many banks -- small and big -- have thereafter reduced interest rates on deposits.

If CPI inflation continues to moderate and remains within the RBI's target range of 4-6%, the RBI may cut the policy repo rate by another 25 bps in the upcoming April 2025 bi-monthly monetary policy 2025-26.

Should this indeed happen, banks would lower their deposit rates in response, diminishing their appeal to depositors.

In such a situation, Equity Savings Funds may be a worthwhile option, owing to the lower risk compared to pure equity funds and better tax efficiency compared to debt-oriented schemes.

Let's understand more about Equity Savings Funds...

What Are Equity Savings Funds?

According to the Securities and Exchange Board of India (SEBI), an Equity Savings Fund is required to invest a minimum of 65% of its assets in equity and equity-related instruments and a minimum of 10% of the total assets in debt.

SEBI classifies Equity Savings Funds as hybrid funds. Fund managers typically invest in arbitrage opportunities intending to exploit the price difference in the cash and derivative segment of the equity market.

The arbitrage opportunity reduces the impact of volatility as it takes advantage of the price differential, sans speculation.

This makes Equity Savings Funds less volatile compared to Aggressive Hybrid Funds or pure equity mutual fund schemes where the equity component is mostly unhedged (non-arbitraged).

The minimum hedged and unhedged portion in an Equity Savings Fund varies across schemes. Each scheme is required to mention the minimum hedged and unhedged exposure in the scheme information document (SID).

These funds have the flexibility to invest across market caps. Most Equity Savings Funds primarily allocate to large-cap stocks, with some tactical allocation to mid-cap and small-cap stocks.

The debt portion usually comprises high-quality bonds, besides government securities.

Investment Risks to Consider

The mix of equity, arbitrage, and debt creates a balanced portfolio, thereby reducing the overall volatility of the equity component.

In times of market turbulence, the debt component could act as a safety net and may also provide regular income in the form of interest.

Having said that, it is important to note that Equity Savings Funds are not entirely risk-free and do not offer guaranteed returns.

Their performance is subject to the equity market movement and the arbitrage opportunities available.

While Equity Savings Funds aim to capitalise on arbitrage opportunities to reduce volatility, such opportunities are not always available. In these instances, the portfolio's unhedged exposure could increase substantially - potentially to 40% or more - making it more susceptible to volatility.

A higher allocation to midcap and smallcap stocks can further increase the risk.

That being said, on the risk-return spectrum, Equity Savings Funds are positioned way below the pure equity funds. Also compared to aggressive hybrid and balanced hybrid schemes, they are placed slightly below.  But mind you, compared to debt funds and arbitrage funds, the risk is high.

Tax-Efficiency of Equity Savings Funds

One of the biggest advantages of Equity Savings Funds is that they are treated as equity-oriented funds for taxation purposes.

In the case of Liquid Funds and bank FDs, the capital gains and interest are taxed as your income-tax slab (i.e. at the marginal rate of taxation), which could be a disadvantage if you are in the highest tax bracket.

However, in the case of Equity Savings Funds, the capital gains on units held for up to 12 months before redemption are treated as Short-Term Capital Gains (STCG) and taxed at 20%. For units held longer than a year, gains are classified as Long-Term Capital Gains (LTCG) and taxed at 12.5% when such gains exceed Rs 1.25 lakh annually.

Owing to the lower volatility compared to pure equity funds and better tax efficiency compared to debt-oriented schemes (particularly for investors in higher tax slabs), Equity Savings Funds are attracting increasing investor attention. As of January 31, 2025, net Assets Under Management (AUM) for Equity Savings Funds stand at Rs 42,161 crore.

Returns from Equity Savings Funds

The table below outlines the 1, 3, and 5-year returns of some of the top-performing Equity Savings Funds:

The table illustrates the return potential of Equity Savings Funds over various time periods. It exhibits the possibility of earning slightly better returns than a bank FD.

Many public sector banks such as the Bank of Baroda, Canara Bank, and the Union Bank of India offer FD interest rates between 6.80%-7.40% over 1, 3, and 5-year periods. These rates may decline in case the RBI further reduces the repo rate.

That being said, keep in mind that returns on an Equity Savings Fund will be market-linked and that past returns are not necessarily indicative of future returns.

You could consider Equity Savings Funds only if...

• You're willing to take a bit of calculated risk on the moderate side to earn decent market-linked returns.

• Have an investment time horizon of around 3 years or so.

• Seeking a tax-efficient mutual fund investment without committing to a pure equity scheme.

Remember, an Equity Savings Fund aims to provide a balanced mix of assets with lower volatility and tax efficiency.

To Conclude...

Given the current market volatility and the likelihood of bank FD rates becoming less appealing, a sensible allocation to some of the best Equity Savings Funds could be considered.

However, it is crucial to invest in a scheme only after gauging its suitability to your risk tolerance, the broader investment objective, financial goals, and the time in hand to achieve those goals.

If you're seeking long-term capital appreciation, Equity Savings Funds might not be ideal for you. Consult a SEBI-registered investment advisor to make informed decisions.

Be thoughtful in your approach.

Happy investing!

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Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.