Mutual Funds Should Stop Inflows in Their Active ELSS Before Launching Passive ELSS

Mutual fund houses may introduce passive ELSS (via Index Fund), and these schemes will be benchmarked to a particular index in the passive mode without the involvement of a fund manager. Passive ELSS funds would be based on selected indices composed of stocks from the top 250 market capitalisation companies. This means that passive ELSS can invest predominantly in large-cap and mid-cap companies, tracking indices such as Nifty 50, Nifty 100, Nifty 200, Nifty Large Midcap 250, etc.

However, there has been one caveat in this regulation of launching Passive ELSS. According to SEBI's circular, 'Categorisation and Rationalisation of Mutual Fund Schemes', it has been decided that mutual funds can launch either of the following ELSS scheme in open-ended Scheme Category, subject to compliance with guidelines on Equity Linked Saving Scheme, 2005 notified by Ministry of Finance:

- Active ELSS Scheme - In terms of Clause A (10) of Annexure of the SEBI Circular dated October 06, 2017, under the "Equity Schemes" category or;

- Passive ELSS Scheme (through Index Fund) - In terms of Clause E (1) of Annexure of the SEBI Circular dated October 06, 2017, under the "Other Schemes" category.

Asset Management Companies (AMCs) cannot have both active and passive ELSS funds. They need to choose between the two options.

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However, recently the market watchdog SEBI on January 10, 2023, in a letter addressed to the Association of Mutual Funds in India (AMFI) stated that, "Based on feedback received from the stakeholders, it has now been decided that mutual funds having existing actively managed open-ended ELSS scheme may launch passively managed open-ended ELSS schemes after stopping fresh inflows/subscriptions to existing actively managed open-ended ELSS scheme."

How Mutual Fund Houses can launch a Passive ELSS in 2023?

According to SEBI, mutual fund houses offering actively-managed ELSS, are allowed to launch a passive ELSS under their tax-saving products basket only after they stop accepting fresh money/inflows in their existing active ELSS plans. The AMCs need to ensure the closure of the existing actively-managed ELSS fund for subscription before introducing a new passively managed ELSS in the market.

In the recent circular, the procedure for launching a passive ELSS scheme by a fund house already having an actively-managed ELSS scheme has been highlighted.

Here are the steps to be followed by AMCs to proceed with the launch of Passive ELSS:

Step #1 - The fund house must ensure to stop all fresh inflows/subscriptions, including Systematic Investment Plans (SIPs) and Systematic Transfer Plans (STPs), from the actively managed ELSS scheme after a written communication about the proposed change.

The disclosure in the letter should also clearly highlight that the existing active ELSS scheme would be stopped w.e.f dd/mm/yyyy due to the proposed launch of a passively managed open-ended ELSS scheme.

Step #2 - The communication has to be conveyed to each unitholder. AMCs are also required to give an advertisement about the closure of the existing actively managed scheme in a newspaper. It shall be printed in at least one English daily newspaper having nationwide circulation as well as in at least one newspaper published in the regional language where the Head Office of the mutual fund house is situated.

Step #3 - The existing active ELSS scheme will have to be kept open for redemptions. Investors should be given the option to redeem their units without exit load by the fund house, subject to lock-in requirements. In addition, the exit option should specifically inform the investor that in case the investor doesn't exit the scheme, the investments would be managed through a passively managed open-ended ELSS scheme.

After completing 3 years from the date of discontinuing inflows in the actively managed ELSS scheme, it will be merged with the passive ELSS scheme, and the investments would be managed passively thereafter. AMCs are required to make suitable disclosures to investors for merger with the Passive ELSS schemes, subject to obtaining necessary approvals from SEBI.

According to SEBI, the mutual fund house will be able to launch a passive ELSS Scheme, subject to the filing of the Scheme Information Document (SID) with SEBI and receiving a final observation letter.

Should you invest in Active ELSS or Passive ELSS?

Under Section 80C of the Income Tax Act, 1961, tax-saving mutual funds or Equity Linked Savings Schemes (ELSS) assist you in reducing your income tax. You can invest a maximum of Rs 1.5 lacs in ELSS and claim tax deductions on your investments every financial year. The tax season is around the corner, and many investors are seeking to invest in tax-saving mutual funds.

Currently, there are over 37 ELSS or tax-saving mutual funds in India offered by different mutual fund houses. Recently, IIFL Mutual Fund launched India's 1st passively managed ELSS fund - 'IIFL ELSS Nifty 50 Tax Saver Index Fund.'

Passively managed schemes have been gaining traction over active schemes lately thanks to their relatively lower costs and better performance. With the active vs passive debate, investor's sentiment in the mutual fund tax-saving market appears to be divided. While some believe the recently introduced passive ELSS to be a better option since they are free of the risk associated with active stock selection, others want to continue with active ELSS funds because they think the 3-year lock-in gives fund managers enough flexibility to generate superior returns.

Now, whether to invest in active ELSS or Passive ELSS for tax-saving purposes completely depends on the investor's needs, risk profile, investment horizon and objectives. Therefore, while choosing an ELSS for your portfolio, you must ensure the fund's suitability and simultaneously check if it complements the other non-ELSS funds in your existing portfolio.

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Warm Regards,
Mitali Dhoke
Research Analyst