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Fund houses with an active tax-saving Equity Linked Saving Scheme (ELSS) can launch passive ELSS funds if they suspend new investment into the active programme.

ELSS are tax-saving mutual funds that need to invest a minimum of 80% in equities. It has a minimum lock-in period of three years and can be used to reduce taxable income under Section 80C.

The regulator launched the passive ELSS category in May 2022 in a circular titled “Development of Passive Funds.”

As per the market regulator’s circular on mutual fund standardisation in 2017, fund houses can only have one scheme in one category. As a result, most fund houses could not launch passive ELSS funds.

What do the new developments mean?

• After publishing an announcement outlining the planned change, fund houses are required to suspend new investments into the already actively managed ELSS schemes.
• After giving sufficient notice to investors, any Systematic Investment Plans (SIPs)and Systematic Transfer Plans (STPs) into the currently actively managed ELSS should likewise be discontinued, according to SEBI.
• Investors in the current ELSS plan should be able to redeem their units, subject to the three-year lock-in term.
• Fund houses may have to submit new documents to SEBI for the introduction of passive ELSS schemes.
• Fund houses must also tell investors that their investments would be handled as passive funds if they do not participate in an actively managed ELSS plan three years following the cessation of new inflows.
• A three-year notice of the closure of an actively managed ELSS scheme must be filed with SEBI by MF.

What does the introduction of passive ELSS funds mean for investors and fund houses?

Most established fund houses have popular tax-saving mutual funds that have gained traction on the back of attractive returns. Hence, fund houses with popular ELSS funds might not welcome this move with open arms.

This move might benefit conservative investors who want to invest passively in equities and save tax at the same time.

Passive ELSS funds can be a good addition for passive investors.

Investors will also immediately benefit from a lower expense ratio, allowing them to save more money in addition to the tax advantage. Passive funds have a lower expense ratio as it is not actively managed.

 This move is likely to be advantageous to new fund houses or MF houses that want to introduce an ELSS fund.

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