What are Passive ELSS funds? Should you invest in Passive ELSS funds?

The SEBI has recently permitted AMCs to choose between offering active and passive ELSS funds

Passive ELSS funds

ELSS is short for Equity Linked Savings Scheme. As the name suggests, it is a mutual fund scheme to save on taxes. ELSS funds are invested in equities, and this scheme is operational under Section 80C of the Income Tax Act, 1961. It is the only mutual fund scheme under Section 80C that provides tax benefits to investors. You can invest up to Rs. 1.5 lakhs per year in ELSS, but you must note that your funds will be locked for three years once you invest in the ELSS. This will reduce your taxable income and the yearly tax imposed upon you and help you save up to Rs. 46,800 in a year. If you invest in an ELSS, your portfolio will be dominated by instruments linked to equity. A very good example of such an equity-linked instrument is shared. 

Till now, ELSS funds throughout India are active funds which implies that the funds are managed by, and the fund managers take the investment decisions. Thus, the fund managers decide the portfolio of the fund. According to the Securities and Exchange Board of India, at least 80% of the assets of these tax-saving mutual funds must be invested in equities. However, according to the recent circular released by the SEBI, fund houses can choose between an active ELSS fund or a passive ELSS fund. 

RelatedDifferent types of funds available under mutual funds

Passive ELSS funds structure:

The main difference between passive and active ELSS funds lies in the investment portfolio and the cost. The fund manager will take investment decisions in the case of an active ELSS fund. However, in the case of a passive ELSS fund, stocks from the top 250 companies in market capitalization will be considered. The passive ELSS funds will be based upon the chosen indices, which are made up of these stocks from the top 250 companies. A passive ELSS fund will follow the benchmark of its active counterpart. Thus, your exposure will be limited only to the top companies, 250, if you invest in a passive ELSS fund.

The expense ratio is the annual amount a fund house charges you for managing your fund. Passive funds have a lower expense ratio when compared to active ELSS funds and hence, are cheaper. This can help the investor receive higher returns from the passive ELSS fund investment and save some more in the long term.

Introducing passive ELSS funds could be to avoid or reduce the clutter of mutual funds and encourage new AMCs to offer passive ELSS funds. However, there is one huge disadvantage to this. The AMCs will be allowed to choose between active and passive ELSS funds, but they cannot offer both, at least not at the moment.

Related: Passive Funds Vs Active Funds: Which one should you pick?

It is already evident that AMCs with existing active ELSS funds may not be permitted to shift to passive funds. All AMCs or fund houses have ELSS funds except very few ones. Some of the active ELSS funds are quite huge and have a higher expense ratio than the ones investing. This, consequently, will have a higher revenue impact on the fund houses offering active funds when compared with the revenue impact on the AMCs offering passive ELSS funds. Thus, the fund houses may not be enthusiastic about offering passive funds instead of active ones. And since the fund houses cannot offer both types of ELSS funds, only the new ones or do not already have active ELSS funds may launch the scheme for passive ELSS funds. Also read, What is passive income portfolio and how to build it?

Passive ELSS Mutual Funds

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