The category of equity savings funds was born in 2014 out of the tax arbitrage opportunity thrown open post the budget announcement that year. Prior to the budget of 2014, debt funds were taxed at long-term capital gains of 10 per cent after a holding period of one year. The budget of 2014 changed the holding period of debt mutual funds to qualify for long-term capital gains tax treatment from 12 months to 36 months. This meant that if investors sold their debt-oriented fund within 3 years, they would end up paying a higher capital gains tax as per their tax slab. The long-term capital gains tax rate was also increased to 20 per cent with indexation. As a result, debt funds lost a bit of appeal. But how about a fund that behaves like a debt-oriented one on risk and returns but is taxed as equity? The idea had tremendous appeal and it snowballed into the birth and rapid rise of the category of equity savings funds. These funds have a mandate to invest about a third of your money each in equity, debt, and arbitrage opportunities, the latter being the key lever. Arbitrage positions are considered equity for taxation but behave like debt on risk and returns. So effectively, an investor gets 65% debt and 35% equity portfolio but it is taxed like equity. The category gained quick acceptance in those early years. In fact, many fund houses rushed to convert their conservative hybrid funds (which invested in debt and equity in the ratio of 25:75) into equity savings ones and all went well until 2018. But since then, the category has witnessed a sharp decline in popularity. This can be attributed to the re-introduction of long-term capital gains tax on equity funds in 2018 which took some sheen off the tax arbitrage proposition. Their higher expenses in the context of only a limited equity allocation is also a spoiler. Furthermore, the rise of balanced advantage funds (BAFs), its more seductive sibling, has also hurt. As a result, the assets of these funds plummeted. But since last year, they have scripted a resurgence with sustained inflows. These are encouraging signs. The investment case The changes to the tax laws, the growth of BAFs or the rise and fall in AUM haven't taken much away from the appeal of equity savings funds for conservative investors who need a moderate equity allocation in their portfolio. These are typically investors with a medium investment horizon of 4-5 years or those looking for an income solution in a simple, convenient, hands-off package.
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