With wild fluctuations in stock markets almost every day, many investors feel stock investing is beyond their risk appetite. Fortunately, there is another class of investments that can help alleviate the risks by diluting the amount of stock holding in the portfolio.
Known as the Equity Savings Scheme, it adds debt and arbitrages to the mix so that the risks associated with a pure equity investment goes down drastically. It works well for the risk-averse investors who worry about market correction eroding their profitability from equity investments
Why does it help?
A typical allocation of equity savings scheme comprises of 30% equity, 30% debt, and 40% arbitrage portfolio. It is well positioned to capture the benefits of an equity market especially when it is on a rally. At the same time, investors remain adequately protected from the downside in case of a market correction.
1 – Arbitrage allocation
With arbitrage allocation, there is a potential for steady yields minus the taxation impact. With this component, it is taxed as an equity fund. The arbitrage position means that the risk factor too goes down substantially. The use of such derivative strategies with the help of arbitrage investment brings down the risk element to a manageable level.
This provides ESS with three distinct benefits
1 – Growth potential associated with equity investment
2 – Better income generation opportunity than banks or post office savings
3 – Tax efficiency if the fund is held for more than a year
2 – Better tax efficiency
From a taxation point of view too, investors get a better deal with equity savings scheme. While interest earned on traditional bank savings is taxed, it is not so with ESS. If the holding is for more than a year, then there is no tax on the returns earned from the scheme.
It is worth noting that if you surrender your investment before one full year, then the returns will be taxed at 15% in the form of short-term capital gains tax.
Compare this to a pure debt fund. This type of fund attracts tax on both short-term as well as long-term capital gains. This explains why ESS is good from a taxation perspective.
3 – Better protection against losses
ESS funds carry 1/3rd equity and 1/3rd debt, with arbitrage making the rest of the composition. The structure of the funds makes it is a natural cushion against losses from market volatility. For example, if the market falls by 10% in 6 months, the returns generated by the other two components (i.e. debt and arbitrage) during the same months will offset the equity losses to a great extent.
Investors who do not have the risk appetite to bear the immense market movement in equity investments now have the option to choose another alternative. They can pick an equity savings scheme and drive better returns than pure debt investments. Besides, they can remain better protected against huge losses due to limited equity exposure in the overall mix.