As a mutual fund investor, are you keen on investing in equity savings funds now?
If you haven't considered this category so far, it's about time you do.
At a time when equity markets are rallying with renewed energy, investing in equity-oriented funds that don't fully invest in equity might sound a tad bit defensive to many of you.
But doesn't it make sense not to become irrational, even when markets are behaving irrationally?
Why might it make sense to invest in equity savings funds in 2019?
At the current juncture, Indian equity markets are expensive, yet they are rallying. If you deploy more money into equity assets without preparing for the possible volatility the markets might experience around elections, you could be in for a nasty surprise.
Those who had increased their investments in equity towards the end of 2007 repented later in 2008 when markets fell drastically.
So is avoiding equity assets completely the solution?
Certainly not!
What happens when the markets rally further?
You wouldn't like to miss the bus, right?
Hence, Equity savings funds could be the solution.
What equity savings funds are?
Equity savings funds aim to take measured exposure to equity and serve a dual objective of providing capital appreciation and income distribution.
According to SEBI categorisation norms, equity savings funds are open-ended equity-oriented schemes that invest in equity, arbitrage, and debt. They have to maintain equity exposure (which includes both, hedged and unhedged positions). Moreover, their minimum debt exposure shouldn't be less than 10%, as per SEBI's classification criterion.
Mutual funds must mention the minimum hedged and unhedged exposure in their Scheme Information Documents (SIDs).
Risk profile of equity savings funds...
Usually, equity savings fund take a hedged equity exposure (with arbitrage opportunities) up to a maximum of 60%-75% of their portfolio. The unhedged equity exposure is around 15%-25% and the balance is held in debt instruments. Being equity-oriented, with a net equity exposure in excess of 65% towards equity, these funds enjoy the same tax benefits like any other equity scheme.
For equity savings funds, the arbitrage portfolio is low-risk, despite investing in derivatives, because fund managers of these schemes do not place speculative bets. If there are no arbitrage opportunities available, the scheme has the flexibility to invest in debt. However, if the overall equity exposure falls below 65%, the scheme could lose its equity status.
Risk return trade off: Equity and debt oriented schemes
Note: for illustrative purpose only,
(Source: PersonalFN Research)
Therefore, on the risk parameters, equity savings funds can be placed below balanced hybrid and aggressive hybrid funds. However, as compared to pure debt funds or arbitrage funds they expose investors to higher risk.
Taxation
If redeemed within a holding period of one year, Equity Savings Funds will attract a STCG tax of just 15%. Equity Savings Funds will attract a LTCG tax of just 10% for gains in excess of Rs 1 lakh. In this case, the minimum holding period to qualify as LTCG is one year. Although dividends are tax-free in in the hands of investors, fund houses pay a dividend distribution tax of 11.65%, including surcharge and cess).
How have equity savings funds performed?
The year 2018 was a tough year for equity savings funds. While most of them managed to generate positive returns, considering their objective of capital appreciation and income distribution, the year gone by wasn't an exciting one for them.
Nevertheless, the 1-year and 3-year returns suggest that many of them have managed to beat pure debt funds and have generated superior returns as compared to other fixed-income options.
Table: Top 10 equity savings funds of 2019
Data as on March 21, 2019
(Source: ACE MF)
*Please note, this table only represents the best performing Equity Savings Funds based solely on past returns and is NOT a recommendation.
Mutual Fund investments are subject to market risks. Read all scheme related documents carefully.
Past performance is not an indicator for future returns. The percentage returns shown are only for an indicative purpose. Speak to your investment advisor for further assistance before investing.
Equity savings funds that have done well are:
Axis Equity Saver Fund(G)-Direct Plan
DHFL Pramerica Equity Savings Fund(G)-Direct Plan
Kotak Equity Savings Fund(G)-Direct Plan
ICICI Pru Equity Savings Fund(G)-Direct Plan
HDFC Equity Savings Fund(G)-Direct Plan
Be careful about equity savings funds that have generated negative returns which include:
L&T Equity Savings Fund(G)-Direct Plan
Reliance Equity Savings Fund(G)-Direct Plan
Aditya Birla SL Equity Savings Fund(G)-Direct Plan
So should you invest in funds that have done well in 2018?
Learn more...
Selection of equity savings funds
According to the SID of Axis Equity Saver Fund, it aims to hold 20%-45% of its portfolio in unhedged equity component, under normal circumstances. However, the indicative overall equity exposure of the fund is 65%-80%. In other words, depending on opportunities available, the fund might vary its unhedged position. If the equity outlook is unattractive, the fund might go slow on unhedged positions and vice-a-versa.
Interestingly, it aims to maintain equity allocation in the range of 20%-70% when market conditions are tough and money market instruments offer better prospects.
As you might have noticed, the success of any equity savings scheme largely depends on its unhedged equity positions, its ability to identify arbitrage opportunities and identify market extremes. The Fund's ability to take tactical asset allocation calls is one of the most crucial factors for an equity savings fund.
Take another example. According to the indicative asset allocation given in the SID, SBI Equity Savings Fund aims to maintain unhedged equity exposure in the range of 20%-50%, under normal circumstances. Moreover, it also intends to invest upto 10% of its assets in Real Estate Investment Trusts (REITs). Under defensive market conditions, it may increase its debt and money market allocation to 70%.
This reiterates the fact that the asset allocation chiefly decides how an equity savings fund might perform. Thus, consistency of the fund house and process-driven approach are the key parameters for selecting right equity savings fund for your portfolio.
Don't get swayed by past performances. If you decide to invest in equity savings schemes in 2019, opt for direct plans.
Factors to consider while investing in equity savings funds...
Quantitative Parameters
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Performance and risk analysis
This is to analyse if the fund has shown consistency in performance across various market periods with decent risk-adjusted returns.
Under this, the fund needs to be ranked on quantitative parameters like rolling returns across short-term and long-term periods, such as 1-year, 3-year, and 5-year as well as on risk-reward ratios like Sharpe Ratio, Sortino Ratio, and Standard Deviation over a 3-year period.
[Read: Why Comparing Returns to Risk Is More Meaningful!]
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Performance across market cycles
You need to ensure that the fund has the ability to perform consistently across multiple market cycles. Therefore, compare the performance of the schemes vis-a-vis their benchmark index across bull phases and bear market phases.
A fund that performs well on both sides of the market should rank higher on the list.
Qualitative Parameters
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Portfolio Quality
Adequate Diversification - The scheme should not hold a highly concentrated portfolio. The portfolio should be well-diversified and the exposure to the top-10 holdings should be ideally under 50%.
Credit Quality - For debt component, you need to ensure that the fund does not hold a high proportion of low-rated (securities rated AA or below) or unrated debt instruments. A fund with a higher credit quality should be ranked higher.
Low Churn - Engaging in high churning can result in trading and high turnover cost. Therefore, you also need to consider the portfolio turnover ratio and expenses, and penalise funds involved in high churning, i.e. those funds with a turnover ratio of more than 100%.
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Quality of Fund Management
You also need to consider the fund manager's experience, his workload, and the consistency of the fund house. Therefore, assess the following:
The fund manager's work experience: They should have a decent experience in investment research and fund management, ideally over a decade. But note that experience isn't always enough. Some schemes managed by fund managers with 15-20 years of experience haven't necessarily done consistently well for a long time.
The number of schemes managed: A fund manager usually manages multiple schemes. Thus, you need to check if the fund manager is not loaded with a large number of schemes. If they are managing more than five open-ended funds, it should raise a red flag.
The efficiency of the fund house in managing your money: Do your research about the fund house's consistent performance across schemes. Find out if only a few selected schemes are doing well. A fund house that performs well across the board is an indication that their investment processes and risk management techniques are sound and efficient.
Watch this short video on selecting mutual fund schemes:
Remember this when you invest in mutual funds:
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Clearly identify your financial goals.
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Recognise the financial goals you want to achieve and align them with your mutual fund investments.
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Gauge the time horizon before the financial goals befall.
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Assess your risk appetite. Unless your risk appetite is moderately high, don't invest in equity savings funds. Conservative investors would be better off investing in low-risk debt mutual funds and other fixed-income investments.
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Based on your risk appetite, draw up a personalised asset allocation chart and invest accordingly.
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Keep reviewing your investment to ensure you're on track to accomplishing your envisioned financial goals.
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Author: PersonalFN Content & Research Team