What are Passive ELSS Funds?

Padmaja Choudhury   /   May 30, 2022
Passive ELSS Funds

Fund houses can either offer active or passive ELSS funds to their investors.

Fund houses can now  introduce passive ELSS funds. In a circular from May 23, SEBI said that mutual funds could either introduce an ELSS scheme that is actively managed or passively managed, but not both.

Equity Linked Savings Scheme (ELSS) is a tax saving mutual fund scheme that invests in equities. Investments in ELSS funds come under section 80C, and investors can reduce their taxable income by investing a maximum of Rs.1.5 lakhs in ELSS funds. ELSS has a lock-in period of three years.

Currently, ELSS funds are active funds. This means that fund managers manage the funds and take investment decisions. As per the SEBI’s Categorization and Rationalization of Mutual Fund Schemes, these tax-saving mutual funds must invest at least 80% of their assets in equities.

Passive funds, on the other hand, replicate the underlying benchmark. So, a passive fund will invest in the companies in the same proportion as the benchmark.

Let us see the different aspects of passive ELSS funds.

Structure of passive ELSS funds

Passive ELSS Funds
  • The SEBI circular, which also goes into effect on July 1, says that the passive ELSS scheme must be focused on indices that include equity shares from the top 250 companies by market capitalization.
  • This means that we can compare passive ELSS funds to indices like Nifty 50, Nifty Next 50, and Nifty100.
  • SEBI said that investors would understand index funds better if the name of the ELSS scheme included the name of the index that the fund is based on.

Differences between active and passive ELSS funds

Passive ELSS funds will provide investors with the benefit of index funds along with tax-saving benefits.

Portfolio: The investment decisions of an active ELSS fund depend on the fund manager and the processes set by the fund house. At the moment, most ELSS funds invest in large-cap stocks. But they can invest in mid cap and small-cap stocks as well. As mentioned above, the fund manager needs to ensure that 80% of the portfolio is invested in equity instruments.  

However, things would be a bit different with passive ELSS funds as the passive fund has to replicate its underlying benchmark. In passive funds, you will only have exposure to the top 250 companies by market capitalization, and the allocation will be the same as the index.

Cost: Passive funds are cheaper, i.e., they have a lower expense ratio than actively managed funds. It is because there is no active involvement of fund managers. The expense ratio is the annual expense that a fund house charges for managing the fund. So, an ELSS passive fund will be cheaper than an active ELSS fund.

Let us look at the expense ratio of one passive large cap fund and ELSS of Aditya Birla Sun Life Mutual Fund. The expense ratio of the Nifty 50 Index Fund is 0.33%, while the expenses charged on the Tax Relief 96 fund is 0.95%.

A lower expense ratio can help you get higher returns and save on costs over the long term. Conclusion: SEBI has allowed fund houses to introduce passive ELSS funds. However, it needs to be seen whether fund houses will introduce passive ELSS funds as they can’t have both active and passive ELSS funds.

The only money management App you will need
Download Wealthzi app now!