Equity Saving Schemes: Exposure to Equity, Arbitrage, and Debt

Equity Savings Schemes (ESS):

Equity saving schemes are open-ended hybrid mutual funds that invest in equities, debt, and arbitrage positions. SEBI introduced this category of schemes in 2014. As per SEBI, an equity savings fund should invest at least 65% of the total assets in equity and its related securities, including arbitrage positions, and at least 10% of total assets in debt securities. Each fund’s exposure to equity, debt, and arbitrage varies within the range specified in the above regulation.

The Three Components Advantage:

The significant difference between aggressive, conservative, and equity savings schemes in the hybrid fund’s segment is that aggressive and conservative funds primarily focus on generating returns using two asset classes (equity and debt). While “Equity savings schemes” include arbitrage positions as an addition to equity and debt, thereby giving its investors a broader diversification into a single fund with three different asset classes. In case suitable arbitrage opportunities are not available in the market as per the fund manager’s view, they may choose to invest in debt or liquid funds and wait for the opportunity.

Thus, while the pure equity portion of the ESS tries to beat the benchmark returns, the arbitrage and debt portion try to balance the volatility of the markets. Thereby, dependency on debt assets to counter the volatility of the markets is largely reduced, as the debt portion of the traditional hybrid funds is shared with arbitrage positions.

How does Arbitrage work?

Arbitrage is the purchase and sale of the same asset in different markets; here, investors try to benefit from the price difference due to market inefficiencies.

For example, Mr. Sudheer bought 250 shares of Reliance Ltd. for Rs. 2,500/- each; simultaneously, he sold 1 lot of Reliance futures contract at Rs.2530/- (lot size of Reliance futures contract is 250).

In this case, the spread difference between spot and futures contracts is Rs.30.00. When the spread difference contracts (i.e., Rs. 30/- becomes Rs.20/-) the investor gets a profit (i.e., Rs.10 X 250 = Rs.2,500/-). It's a loss when the spread expands (i.e., Rs.30.00 becomes Rs.40.00). In usual market conditions, the futures contract near to expiry will trade at prices very close to the spot price of the underlying assets. So, arbitragers generate returns with a very low risk of losing a trade.

Advantages of investing in Equity Savings Schemes:

1. ESS are less risky than pure equity funds and aggressive hybrid funds.

2. ESS has the ability to generate higher returns than conservative hybrid funds and debt funds

3. Compared with debt funds, Equity Savings Schemes are more tax-efficient due to their exposure to equity and derivatives.

4. ESS provides flexibility to fund managers in shifting the required portion of funds between derivatives and debt whenever they see an opportunity.

5. The downside risk can be mitigated efficiently by increasing arbitrage positions in Equity Savings Schemes during volatile market conditions.

6. Reduced dependency on debt as a balancing factor.

The ESS category has generated returns ranging from 6.89% to 17.00% for the last 3 years. However, each equity savings fund has a different asset allocation depending on its fund manager’s view.

Thus, choosing the best equity savings fund that suits an individual will require analysis of various factors like investors’ risk appetite, whether the purpose of the investment is income or growth, investment horizon, etc.

We recommend our readers to reach out to your financial advisor, or you could call us at +91 -7305923322 or write to us at research@adityatrading.com for the best equity savings fund that suits your risk profile.

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