With the rise in stocks making investors edgy, pure equity funds may appear risky to new conservative investors. Debt funds have lost a bit of edge, thanks to the removal of indexation benefit. In this backdrop, equity savings funds, which use a mix of equity, debt, and derivatives, are a good option for key reasons. First, they are less volatile and more safe than regular equity funds. Second, they make for a tax-efficient option where you want equity taxation without equity volatility.

We recommend nearly 10-year-old Kotak Equity Savings Fund (rated 4 stars by bl.portfolio Star Track Rating) on account of its consistent returns both in terms of its performance versus category and benchmark, and its conservative approach with respect to no aggressive duration or credit risk.

Equity savings category

Hybrid funds are supposed to be low-risk alternatives to equity funds. Equity savings funds combine tax efficiency with a more conservative, safer exposure to equities. Previously, some of these funds used to be known as ‘equity income funds’. As per SEBI mandate, equity savings fund should have minimum 65 per cent equity and equity-related instruments, minimum 10 per cent allocation to debt instruments and derivatives (minimum for hedging to be specified in the scheme information document or SID).

These funds that invest in equity, debt and arbitrage opportunities do so with an aim to neutralise market volatility. The equity portion covered with an arbitrage exposure is considered hedged. The unhedged portion is the direct equity exposure, which can add an edge to returns. The debt and arbitrage exposures provide stability to the returns of these funds. However, returns also depend on the availability of arbitrage opportunities in the market. From a risk-reward perspective, equity savings funds are positioned between short-term duration debt funds and balanced advantage/dynamic asset allocation funds.

Equity savings funds aim to deliver lower equity exposure (68 per cent vs. 84-96 per cent for diversified equity funds), combined with taxation of equity funds. They do this by utilising equity derivatives in such a way that the returns are predictable and safe, while the investment is still classified as equity for tax purposes. In the last one-, three-, five- and seven-year periods, this category has posted 7.4 per cent, 13.2 per cent, 7.9 per cent and 8.9 per cent returns.

Fund strategy

Kotak Equity Savings Fund is an open-ended equity scheme. In terms of asset allocation, the fund provides for 10-50 per cent in net long equity, arbitrage is 15-80 per cent, and fixed income is 10-35 per cent.

The fund aims to provide income from arbitrage opportunities in cash and derivatives segment of the equity market and debt investments. Potential for growth in the long term is through moderate exposure in directional equity. The equity exposure can vary between 20 per cent and 40 per cent based on market valuations and market sentiments. The fund adopts a conservative approach in terms of no aggressive duration or credit risk (no allocation to below AAA) taken on debt portion. No aggressive mid-cap/small-cap exposure (in-line with category) taken.

Direct plan of the fund costs 1.02 per cent


In terms of trailing returns, Kotak Equity Savings Fund has out-performed its benchmark Nifty Equity Savings TRI (Total Return Index) over one-, three- and five-year basis by 50-150 basis points (1 bps = 0.01 per cent). It is one of the only two funds in this 22-scheme category to do so.

Historically, rolling returns highlight consistent long-term performance. On this parameter, the fund has not given negative returns for two years and above. Its average daily rolling return since inception for one-, two-, three-, four- and five-year period is 8-9 per cent. Importantly, for three years and above periods, 85 per cent of times returns have been more than 7 per cent.

The fund’s strategy has meant that it has lower volatility (standard deviation 1.44 vs. 1.76 for category as per ACEMF) than others. This is also corroborated by the fund’s beta, which is also lower than category average.


Kotak Equity Savings Fund continues to run a conservative portfolio, with maximum exposure in mid-cap and small-cap stocks being 15-20 per cent at any point in time. Currently, mid- and small-cap allocation of the fund is 12.5 per cent. The remaining of the directional equity continues to be in large-cap stocks. The fund is overweight on sectors like Auto, Banks - both private and public, and select consumer names. It has added a few high dividend yield names. The fund’s equity portfolio PE is 24 times compared to 31 times for category.

The arbitrage portion of the fund continues to be managed in the same way the fund house manages arbitrage fund. Arbitrage fund returns are typically 5-6 per cent annually. In months, when the arbitrage opportunities provide better returns than the debt papers, Kotak Equity Savings deploys more money into arbitrage trades.

In the debt field, the fund believe three-six year asset is the sweet spot from the yield curve positioning. As the curve has been relatively very flat over six years, it has been concentrating on assets between three and six years. Average maturity is 3.46 years. The fund is of the view that floating rate bonds provide adequate protection in case there is a sudden shock in rates. Yield to maturity of fund portfolio is 7.48 per cent.

Why buy
Above-average returns along with lower volatility
Consistently better than benchmark over different time periods
No credit risk, capped mid- and small-cap exposure act as good guard rails