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Recently Zerodha announced the launch of the ELSS Tax Saver Nifty LargeMidcap 250 Index Fund. Usually, ELSS funds are active-oriented mutual funds. Investors may have never come across a passive ELSS fund such as an index fund.

So what has changed here? In July last year, Sebi permitted AMCs to provide passive ELSS mutual funds in the form of index funds. Let’s examine whether or not passive ELSS funds are a good fit for your investment strategy.

First, let us understand what an ELSS fund is. Equity Linked Saving Scheme (ELSS) is an equity category of mutual funds that invests primarily in the equity market. It is a scheme where the fund manager invests a minimum 80% portion of the investor’s corpus into equity or equity-related instruments.

Further, an investment upto Rs 1.5 Lakh in ELSS is eligible for tax exemptions and has the shortest lock-in period of 3 years compared to other traditional financial products. Being an equity fund, ELSS is still a high-risk investment.

What are passive ELSS Funds?

Today, investors are drawn to passive funds due to their attractive features, such as low volatility, steady returns, freedom from fund manager bias, etc.

These features make them a great option for conservative investors seeking steady profits with minimal risks. Passive mutual funds follow their predetermined benchmark and attempt to replicate the index’s performance.

Following a circular issued by Sebi on May 23, 2022, Asset Management Companies (AMCs) were permitted to begin offering passive ELSS mutual funds (index funds) beginning on July 1, 2022.

As per SEBI, these funds, along with index funds and Funds of Funds, would be placed in the ‘other schemes’ category, while the pre-existing ELSS funds will be referred to as active ELSS funds and placed in the equity mutual funds category.

Like other passive funds, passive ELSS funds will mimic the performance of a selected benchmark or index as closely as possible. The fund’s market capitalisation is limited to stocks of the largest 250 companies in the market. Therefore, indices like the Nifty 50, Nifty 100, Nifty 200, etc., can serve as the benchmark for passive ELSS mutual funds.

Advantage of passive ELSS funds

An important point to note is that AMCs can offer either active ELSS funds or passive ELSS funds, but not both. That said, the expense ratio of passive ELSS mutual funds is lower than that of active ELSS funds currently available, which is an additional benefit of these products.

Equity funds usually have a high expense ratio of 1.5% to 2%, whereas index funds typically have an expense ratio of up to 0.5%. An improved return on investment directly results from a lower expense ratio.

Taxation

Passive ELSS funds have a lock-in period of three years. As a result, investors will not incur any short-term capital gain. However, long-term capital gains on the fund are subject to a 10% tax if they exceed 1 lakh.

Passive ELSS funds qualify for a tax deduction of up to 1.5 lakh per financial year under Section 80C of the Income Tax Act, 1961.

Returns

360 ONE ELSS Tax Saver Nifty 50 Index Fund, formerly known as IIFL ELSS Nifty 50 Tax Saver Index Equity Fund, was the first passive ELSS fund to be launched in India in December 2022, followed by Navi ELSS Tax Saver Nifty 50 Index Fund in March 2023.

Zerodha Mutual Fund launch of the Zerodha ELSS Tax Saver Nifty LargeMidcap 250 Index Fund would be the third passive ELSS fund to join India’s bandwagon of passive ELSS funds.

In the last six months, the average returns these funds have given is 8% as per Ace mutual fund as of November 7, 2023.

So, should you invest in passive ELSS funds?

With the extra benefit of tax savings, passive investment will appeal to investors. It can attract conservative investors who might otherwise avoid active ELSS funds, expanding the funds’ potential investor pool.

Conclusion

Investors should wait and watch as they are relatively new to the passive investment category. The help of a financial expert is recommended to identify your risk appetite.