However, fund houses can either have an actively operated ELSS scheme or a passive scheme.
In addition, the market regulator has mandated that the passive ELSS The scheme should be based on one of the indices containing equity shares of top 250 companies in terms of market capitalisation.
ELSS is the only tax saving mutual fund category under which an investor can avail tax deduction up to a maximum of Rs. 1.5 lakh in a financial year under section 80C of the Income Tax (IT) Act.
Active ELSS funds, which are currently offered by most fund houses, allocate at least 80% to equity and the rest to debt instruments and the money is locked in for a period of three years.
Apart from tax saving benefits, ELSS schemes also act as an investment option, as this category has given an average return of 12% on a three-year basis and 15% on a 10-year basis.
Let us see whether passively managed ELSS schemes will work for investors or not.
Dhaval Kapadia, Director-Managed Portfolio, Morningstar Investment Advisor India
Passive ELSS funds will be low cost
It has been challenging for Indian mutual fund houses to generate alpha for active funds over the years. In the ELSS category, less than 30% of funds have been able to outperform BSE 500 (Total Return Index) on the basis of three year and five year annualized returns (as on 24th May 2022). In the past one year, less than 40% of ELSS funds have outperformed the BSE 500 index.
Hence, it makes sense to opt for passive funds in the ELSS category.
Relative to active funds, passive funds will be lower cost. Further, as per the recent SEBI guidelines for passive ELSS funds, the underlying index being tracked by the fund should consist of top 250 stocks by market capitalisation. It offers an option to invest in a wide basket of stocks in large-cap and mid-cap.
Shivanath Ramachandran, Director Capital Market Policy (India), CFA Institute
Active ELSS seeing poor performance
The main argument for passive option is the poor performance of active ELSS schemes as compared to benchmarks in recent years. There are a few caveats, including the fact that benchmark returns are not adjusted for fees — an average of about 25 bps in index funds based on my calculations. Even with fees, more than half of the plans would have performed poorly. The performance loss of active ELSS is not one-sided either; The respective numbers were worse at the end of 2020.
ELSS is one of the attractive tax saving options and introducing passive ELSS improves the choice and outcomes of investors. Tax-saving options are generally closer to the last day, when people have little time to evaluate options – from that point of view, passive ELSS minimizes regret.
Tarun Birani, Founder and CEO, TBNG Capital Advisors
Sequencing helps limit behavioral bias
Passive ELSS funds make complete sense as a tax-saving option when paired with an opportunity for novice investors or busy professionals to dive into investing via the low-cost passive route. While these investments are now limited to investing in large-cap funds, individuals with long-term investment goals can take advantage of this opportunity. Indexing has demonstrated good investment experience over a long period of time. Along with the low cost, sequencing helps to reduce the person-oriented behavioral bias in investment.
This decision may not be entirely favorable for fund houses, especially considering that most of them already have active funds in their portfolio basket. It remains to be seen whether SEBI will open its doors to allow the fund house to launch both the products.
Saurabh Gupta, Fund Manager-Equity, Quantum Mutual Fund
Dormant ELSS funds will take time to grow
From an investor’s point of view, a passive ELSS fund would be a good option. However, most of the fund houses including us already have an active ELSS scheme. Also, if a fund decides to launch a passive fund, it will take at least three years, as they will have to close the active scheme. Also, a passive ELSS can be based on different indexes. Some houses may replicate large-caps, while others may replicate certain other indices. Although the top 250 stocks are capped, we feel there will be no parity on what the product could be, and how they compare to each other. So it’s a challenge.
Investments in ELSS funds are locked in for three years. Hence, fund managers can think of a longer term to invest that money. Active funds still make more sense in this category than passive funds.