Edelweiss Equity Savings Fund completed four years in October 2018. What’s so special about it? This was the first equity savings fund launched in India that promised to give a mutual fund monthly income scheme (MIP) type of returns to investors, but with equity taxation.

Today, there are 16 schemes in this category with a collective size of Rs 21,350 crore. Last year when the capital market regulator, Securities and Exchange Board of India (SEBI) came out with a circular that re-classified MF categories where it told all MFs to classify all their schemes into, ‘equity savings’ was one of the categories.

These are schemes that invest in a mix of equities and fixed income instruments and about a third of their portfolios in arbitrage opportunities. Put the arbitrage and equity components together and the fund’s overall equity exposure hits 65 percent, which qualifies it to earn equity taxation.

For years, fund houses have sold MIP to investors with an aim to give them some sort of a regular income in form of dividends. In reality, MIPs have been a misnomer. They do not and cannot assure monthly income.

But that wasn’t the only problem with MIPs, now known as conservative hybrid fund after SEBI re-classified mutual fund schemes. They are taxed like debt funds. Withdrawals within three years attract short-term capital gains tax as per your income tax brackets and 20 percent long-term capital gains tax with indexation benefits if you hold on to your units for more than three years.

Equity savings funds were a sort of innovation that aimed to give MIP-type of returns, but with an equity taxation twist. The question is, have equity savings funds worked? And, do they make sense or are they too complex?

Performance on par

Although many equity savings funds’ records show that they were launched many years ago, they were actually different funds before. And they later turned into equity savings funds. Therefore, if you wish to see their track record, check out their performance since 2014. That’s not much of a history to begin with, but let’s see how they’ve done so far.

Apart from comparing them against conservative hybrid fund, we also compared their performances against short-term debt funds. Between 2014 and now, we checked out a series of 1-year returns with a gap of a month, November 2017 to November 2018, October 2017 to October 2018 and so on.

Equity savings funds outperformed short-term bond funds 25 out of 40 times. When compared with conservative hybrid funds, equity savings funds outperformed just 12 of 40 times, as per Value Research’s data.

We avoided all those funds that changed their character after SEBI’s re-classification exercise because such schemes’ past performances are irrelevant as they had different mandates back then.

“On a post-tax basis, because of its equity status, equity savings funds would be bit lucrative, but not much, especially given the fact that from this year, equity funds (and by virtue, equity savings funds) also now attract 10 percent long-term capital gains tax,” says Kaustubh Belapurkar, director, fund research, Morningstar India, a US-headquartered MF tracking and research firm.

A complex portfolio

But a better taxation status is no guarantee to winning returns. Since equity savings funds typically hold 30 percent in equities, they are prone to market volatility. Also within their equity holdings, how much large-cap stocks and how much mid-cap stocks they hold also make a difference to their performance.

“Many of these funds used to hold equities between 25-40 percent in equities. The downside was that most of these funds didn’t really have a coded methodology to decide their equity allocation. It depended on fund manager’s analysis. Some funds, though, had criteria such as price-to-book ratio to determine how much equity they should hold”, says Nithin Sasikumar, co-founder and head-research, Investography Ltd, a Bengaluru-based wealth management firm.

Between July 2017 and April 2018, DHFL Pramerica Equity Savings Funds had 13 percent in mid-cap stocks on an average. Since then and until now, its midcap exposure has been 8 percent on an average. It returned 4.23 percent over the 1-year period ending November 2018. Aditya Birla Sun Life Equity Savings Fund held 17 percent in midcaps on an average throughout 2018. Its 1-year return ending November 2018 was -1.22 percent. In other words, it lost money.

High expense ratios a spoiler

The big dampener for equity savings funds is the expense they charge to investors. The costs that a mutual fund scheme charges- along with how well its underlying portfolio- plays a key role in how much money an investor makes.

When Swarup Mohanty, chief executive officer, Mirae Asset Global Investments (India) and his team went to distributors around five to six months ago, to test his firm’s upcoming fund, Mirae Asset Equity Savings Fund, he knew that the fund had just got SEBI’s approval and Mohanty wanted to make the scheme lucrative to investors.

Charge less expenses that could translate into better returns. Equity savings funds have been used to charging expense ratios of 2.1 percent on an average, as per Value Research data. But equity savings funds are designed to return around 8-10 percent returns.

Mohanty believes that for such returns, a 2 percent plus expense ratio is “way too high”. Mirae ultimately launched the fund with an expense ratio of 1.6 percent; anything lower, he said, would not be lucrative for distribution.

That’s the tight balance equity savings. As per Value Research, Principal Equity Savings Fund charges an expense ratio of 2.9 percent. Mahindra Dhan Sanchay Equity Savings Yojana, launched in January 2017, charges an expense ratio of 2.56 percent.

On the other end are schemes like DHFL Pramerica Equity Savings Fund that charges 1.29 percent and Mirae Equity Savings Fund that, Mohanty claims, will reduce its own expense ratio from 1.6 percent currently to “something far lower, now that it’s open for subscription.”

“Most equity savings funds have unjustifiably high expense ratios. For schemes that are designed to give you just about 8 percent returns and has only around 30 percent of its portfolio in equities, a high expense ratio is not justified,” says the product head of a large fund house, requesting anonymity.

What should you do?

Due to a large number of differences in terms of underlying holdings and expense ratios they charge, it’s not easy pickings. These funds are aimed at conservative investors but unless the equity portion is managed deftly and conservatively and expense are kept in check, equity savings funds can face challenges in volatile markets.

“Annual returns of these funds can vary widely. Some of these funds have lost money in the last one year because equity markets have delivered poor returns. This is not acceptable to conservative investors; typically those that equity savings funds are aimed at. Conservative investors want consistency”, says Srikanth Bhagavat, managing director, Hexagon Capital Advisors.

Equity savings also lack a long-term track record. Most haven’t been there for a long time, and others have changed course only in 2018 after the big re-classification exercise.

Further, unless you can zero in on a fund that is conservative and comes with a low expense ratio and at the same time, comes with a good track record, equity savings funds are not the effort. Stick to short-term bond or banking and PSU funds.