Index-based ELSS funds offer cheaper tax saving option

Express News Service

MUMBAI:  Investors looking to save tax and get higher returns are set to get more options to choose from as the stage is set for launch of new schemes by the mutual funds. The Securities and Exchange Board of India’s (Sebi) recent decision has paved the way for mutual funds with active Equity-Linked Savings Schemes (ELSS) to launch passive schemes.

Earlier, mutual funds were allowed to either launch an actively-managed ELSS scheme or a passively-managed one but not in both categories. But, earlier this month, the capital market regulator gave green signal to mutual funds to launch passive schemes.

The ELSS mutual funds aim to maximise portfolio return over the long term while offering tax benefits. Under section 80C of the Income Tax Act 1961, investments of up to R1.5 lakh in ELSS funds are eligible for a tax deduction. 

The investments under the ELSS scheme have a three-year lock-in period, which is the shortest lock-in period as compared to other tax-efficient products. These fund schemes principally invest in stocks, which allows them to generate substantial yields in comparison to other investment avenues like debt-oriented schemes or FDs. The ELSS funds have given returns in the range of 10% to 22% in the last three years.

Cheaper and simpler alternatives
Active funds are comparatively costlier in comparison to passive funds as they have higher expense ratio. Expense ratio is the total cost an investor pays to Asset Management Company (AMC) for management of the fund. The new passive ELSS schemes, which will be launched in coming days, will have lower expense ratios, say experts.

“Typically, all passive schemes for instance Index Funds and Exchange Traded Funds (ETFs) have lower cost as compared to active funds, so passive ELSS schemes will also surely have lower expense ratio. In my view, we can expect most of the ELSS Index Funds to have an expense ratio in the range of 0.75% to 1%,” Anil Ghelani, Head- Passive Investments & Products, DSP Mutual Fund told TNIE.
The net Assets under Management of ELSS equity schemes was R1.55 lakh crore as on December 31, 2022. The net inflows in ELSS equity schemes stood at R564 crore in December last year. 

Experts believe that the new passive schemes will be able to attract investors due to performance and cost. “Existing investors in Active ELSS funds have no option to move to ELSS Index Funds. But yes, for new investments, we could surely see some benefits. This will be driven by two main reasons: performance and cost. Investors could prefer ELSS Index Funds looking at the overall benefits of passive versus active such as relatively lower costs and simplicity,” Ghelani added.

ELSS mutual funds try to keep expense ratios lower from their competitors but most of the active schemes have expense ratios between 0.7% and 1.76%.

Good move for industry
The launch of new ELSS passive schemes is not only good news for retail investors but is also a positive development for the mutual fund industry.  This decision will help the mutual fund industry get more inflow of funds and will expand the reach of products to new customers and wider territories.

“The mutual fund industry has a huge scope for increasing penetration and getting more investors. Often tax saving can be a good tool to get started. And for that, having ELSS as an Index Fund would provide other benefits such as transparency, diversification, relatively lower costs and most important – simplicity. So, a simple to understand investment together with a tax benefit could drive the penetration and increase outreach of the industry,” said Ghelani.

According to experts, the passive ELSS funds are suitable for investors who have comparatively less risk appetite and have a long-term investment horizon. “Investors should also know that the risk remains the same as passive funds will also be having exposure in equities. Thus, it remains completely their discretion as to whether they are looking for active management of funds or a passive way of saving taxes and accumulating wealth over a long period,” Nitin Rao, Head Products and Proposition, Epsilon Money Mart- a wealth management firm, told this newspaper.

“If one is looking for a low-cost option with limited chance of underperforming the benchmark, passive investing is surely an option to consider,” he added. AMCs with a good track record on active ELSS might not opt to launch passive ELSS immediately but AMCs with poor track record will be soon launching passive ELSS, said Rachit Chawla, CEO Finway- a financial services providing firm.

“Sebi allowing mutual funds with active ELSS to launch passive schemes will provide an opportunity for the mutual fund industry to have more inflows of funds and more savings from a consumer standpoint,” said Chawla.

A performance scan

Rs 1.55 lakh cr net AuM of ELSS equity schemes as on Dec 31, 2022

Rs 564 cr Net inflows in ELSS equity schemes in Dec 2022

0.7% to 1.76% Expense ratio of active ELSS funds

10% to 22% Three-year returns of active ELSS funds