Active ELSS Funds AMC can Now Launch Passive ELSS Index Funds. But…

Last year via a circular dated 1st July 2022, the regulator SEBI allowed the launch of passive ELSS funds in India. But there was a rule that AMCs would have to choose between active ELSS or passive ELSS funds. They couldn’t have both in their portfolio. Given that the ELSS fund category already has about Rs 1.49 lakh crore in active ELSS schemes, this odd rule of having to choose between active and passive funds for AMCs made it clear why AMCs would stick to active funds given the higher revenue they bring, both for AMCs and distributors.

But the regulator has now tweaked the rule after feedback from the industry. SEBI has now allowed mutual fund houses with existing active ELSS funds as well to launch passive ELSS funds, provided they stop taking fresh money (lumpsum or SIP/STP) into the existing active plans. This is because at any given time, no AMC can have 2 similar schemes in a given mutual fund category.

But that is not all. All these steps have to be followed by AMCs that already have active ELSS funds and want to launch new passive ELSS funds:

  • Launch the passive ELSS scheme AND stop taking fresh money in existing ELSS funds, simultaneously.
  • Existing unitholders need to be informed about these 2 changes and given the option to redeem their MF units without paying any exit loads, of course, subject to 3-year ELSS lock-in requirements.
  • Once a period of 3-year is complete since the stoppage of inflows in active ELSS funds, it will have to be merged with the passively managed ELSS scheme.

So basically 3-year after the launch of ELSS passive funds, the AMC will have to merge both active and passive ELSS funds to make a single passive ELSS fund.

Apart from the active vs passive difference, everything else remains the same. Like all existing ELSS funds, even passive ELSS funds will provide the dual benefit of tax saving (under Section 80C in old tax regime) and the potential for getting high returns from equity. But since this will be a passive fund, it will have a relatively low cost compared to the actively managed schemes that have higher expense ratio. So considering the tax-saving investment options for cost-conscious investors, the value on offer when investing via passive ELSS funds can be immense for their requirements.

Talking about returns, we need to acknowledge that most active ELSS funds are primarily largecap oriented funds. And in the recent past, it has been very clear that funds with major allocation to largecaps find it tough to give index returns now. Hence for largecap exposure, better to take the passive index fund route. Plain and simple. So, in such a scenario, having an option of investing in passive largecap index fund in the ELSS category definitely makes a lot of sense. And kudos to the regulator SEBI for paving way for passive funds in the popular ELSS category, which is often the first fund in which first-time investors put money.

While most passive ELSS funds too will tend to remain large-cap oriented, the SEBI circular has allowed passive ELSS funds to be based on any index which is only made up of the top-250 companies in terms of market-cap. So, in future, and given the SEBI mandate of investing only in index with stocks from the top-250 universe, we might soon also see passive ELSS funds like Nifty100 Index ELSS fund, Nifty Midcap150 Index ELSS fund, Nifty Midcap50 Index ELSS fund, Nifty200 Index ELSS fund, etc.

Till then, the newly launched or soon-to-be launched passive ELSS funds can be a good choice for first-time equity investors who come with tax-saving in their mind as well and generally compare other tax-saving options like PPF vs ELSS, etc. But those who wish to take additional risks to try and get index-beating returns, can still look at choosing active funds. But selecting the right active fund is not as easy as it looks and not necessarily as easy as picking last year’s winners. Good passive funds eliminate this issue as they only mimic index returns and neither overperforms nor underperforms market indexes.

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