SEBI Allows Launch of Passive ELSS Funds in India – Here’s All You Need to Know

Tax savings is one of the top priorities of every individual. However, when the option to save tax is coupled with the benefit of investments and earning decent returns through the same, it becomes a lucrative opportunity that should not be missed. ELSS funds fall under the category of investments that provide these dual benefits. However, the excessive exposure to equity is what often drives conservative investors away from these funds. The newly launched passive ELSS funds can resolve this issue and integrate more investors into the ELSS fund category.

Given below is the basic meaning of passive ELSS funds and its implications for the investors and the fund houses as well. 

What are ELSS mutual funds?

Before moving towards the passive ELSS funds, let us first understand the existing ELSS mutual funds offered by the fund houses. ELSS mutual funds are the Equity Linked Mutual Funds that invest majorly in equities of listed companies (minimum 80% of the fund). The fund can be made of large-cap, mid-cap, or small-cap companies depending on the investment objective of the fund. These funds, unlike regular mutual funds, come with a lock-in period of 3 years.

 The USP of the ELSS mutual funds is the tax-saving benefit in the form of deduction up to Rs.1,50,000 under section 80C for contributions made to the fund during any financial year. After the completion of the lock-in period, investors can exit the fund at any time after considering the market conditions.

What are passive ELSS funds?

Passive funds have a huge investor base on account of various benefits like limited risk, more or less consistent returns, absence of fund manager bias, etc. These benefits make them ideal for risk-averse investors that aim to get more or less stable returns at manageable risks. Passive funds simply track their set benchmark and aim at matching the performance of the index subject to tracking errors. 

With a view to providing the benefits of passive investing along with tax saving options, SEBI through a circular on May 23rd, 2022 permitted the AMCs to provide passive ELSS mutual funds (index funds) effective from 1st July 2022. These funds will be categorized under the ‘other schemes’ category as per SEBI along with index funds and Fund of Funds while the existing ELSS funds will be referred to or denoted as active ELSS funds and categorized under the equity mutual funds category. 

These funds, like any other passive fund, will track their predetermined benchmark or index and will try to match the performance of the same subject to tracking errors. The underlying assets of the fund can be equities of the top 250 companies as per market capitalization only. Therefore, the benchmark of the passive ELSS mutual funds can be indices like Nifty 50, Nifty 100, Nifty 200, and so on. 

The circular further states that AMCs can provide either active ELSS funds (already in existence) or passive ELSS funds (according to the new circular) but not both at the same time. The current ELSS funds available from the AMCs are all active mutual funds and are heavily dependent on the expertise and experience of the fund manager to generate better returns. This will not be the case in passively managed ELSS mutual funds. 

Another added advantage of the passive ELSS mutual funds is the reduced expense ratio of the fund as compared to the active ELSS funds that are in existence today. For example, the expense ratio of an equity fund is approximately 1.5% – 2%, however, that of an index fund is usually up to 0.5%. This direct benefit of a reduced expense ratio is translated into increased returns for the investors. 

What does the launch of passive ELSS funds imply for fund houses and investors?

The launch of passive ELSS mutual funds has created a lot of buzz in the market and is perceived differently by the AMCs and individual investors. The details of the same are highlighted below. 

1. Fund houses

The introduction of passive ELSS funds cannot be along with active ELSS funds from the same fund house. Hence, for more than 35 AMCs that offer active ELSS mutual funds already, the decision would be to discontinue the same and offer new passive ELSS mutual funds. This may not be welcomed by the AMCs that have successful ELSS funds and are earning good profits from the same. Therefore, the move can currently be beneficial only to new AMCs or fund houses that do not have any ELSS funds and want to tap into this category.

2. Investors

Passive investing has its own set of advantages and with the added benefit of tax savings, it will be quite attractive for the investors. It will increase the investor base for ELSS funds and can include the conservative investors as well that would otherwise stay away from active ELSS funds. Therefore, passive ELSS funds are generally perceived to have been positively received by the investors.

Conclusion

Passive ELSS funds are a step further in making the mutual funds category more attractive and the go-to investment option for every class of investors. The introduction of passive ELSS funds will be an excellent addition to an investor’s portfolio and can be used to balance the overall risk of the same. Fund houses that do not already have an ELSS fund can see this development as a window to enter the ELSS category and increase their investor base. 

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