As asset management companies launch passive equity-linked savings schemes (ELSS), individual taxpayers will find them attractive because the costs will be lower which will add to the fund’s performance in the long run. One of the main attractions in ELSS is tax savings under Section 80C of the Income Tax Act. So, if one clubs savings in expense ratio with the standard index returns, the investment option in passive funds will become more attractive, especially for conservative investors.
The markets regulator has allowed fund houses to launch passive ELSS funds. However, they will have to close the existing actively-managed ELSS fund for subscription before introducing a new passively managed ELSS in the market. The fund houses will give an option to existing investors to redeem their units without any exit load, subject to the lock-in requirements.
After completion of three years from the date of discontinuing inflows, active ELSS will be merged with passive ELSS and will be managed in a passive way. This would give enough time to investors to switch to another active fund if they want or to move to a passive fund.
How investors will benefit
Passive investing comes with its unique set of opportunities and challenges based on what an investor is seeking from a fund. Nirav Karkera, head of research, Fisdom, says as most ELSS funds have a large-cap orientation and a strong case made for index-based passive strategies outperforming most large-cap counterparts, passive ELSS mutual funds offer investors the dual advantage of tax-savings along with capital appreciation through such a strategy. “Passive funds stand to gain significantly over a longer period through well-defined passive strategies, existing tax-saving benefits and incremental performance simply through lower costs,” he says.
Investors who do not want an active call can choose a passive ELSS in the markets. Santosh Joseph, founder, Refolio Investments, says there is a completely new segment of investors who are looking at passives for their investments. “Apart from tax saving and the least lock-in a tax saving product, the passive exposure to the stock market will give one more reason to individuals to invest in ELSS,” he says.
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However, George Thomas, fund manager, Equity, Quantum AMC, says the long-term horizon offered by the three-year lock-in on ELSS schemes offers a better chance to outperform the benchmark. “Considering that next decade is likely to see higher interest rates and normalisation in business cycles, we believe actively managed funds are likely to do relatively better,” he says.
What to look out for
Investors should look at the index the passive ELSS fund is replicating and the fundamental prospects of the constituents and historical returns of the index. Divam Sharma, founder, Green Portfolio PMS, says an investor should also look at parameters of volatility such as standard deviation and also assess risk-adjusted performance ratios like Sharpe and Treynor. “One should look at the expense ratio. Passive ELSS funds will help investors with lower costs. The lower the expense ratio, the better it is for investors,” he says.
Karkera says while assessing the track record, it is important to consider the fund management team’s investment philosophy and style in context of prevailing market conditions. Investors have to be careful about the passive index or the passive underlying strategy. Unlike how an investor selects an active ELSS fund based on its track record or the size of the AUM, the decision to select a passive fund will be a lot easier. Santosh Joseph of Refolio Investments says there could be a large-cap, mid-cap, multi-cap or a broader index strategy like Nifty 500. “So knowing what exposure you want and being able to get that in an ELSS passive scheme is important,” he says.
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What to choose
In the long run, whether to choose active or a passive ELSS will depends on the individual investor’s goals and risk tolerance. Active ELSS funds have the potential to deliver higher returns than the benchmark index. However, it comes with higher fees and the risk that the fund manager’s decisions may not turn out to be correct.
Sonam Srivastava, founder and CEO at Wright Research, says in passive management, where the fund tracks a benchmark index and does not involve active security selection or trading, tends to have lower fees and a lower risk of underperforming the benchmark. However, it also means that the fund’s returns are likely to be similar to the benchmark, rather than beating it. “In the long run, both active and passive management have their advantages and disadvantages. It is important for investor to understand their own investment goals and risk tolerance and choose the strategy that aligns best with their needs,” she underlines.
GETTING passive investing RIGHT
* Look at the index the passive ELSS fund is replicating and the fundamental prospects
of the constituents and historical returns of the index
* In the long run, whether to choose active or a passive ELSS will depend on the individual investor’s goals and risk tolerance. So, choose strategically