Monday, November 06, 2017

FUND FLAVOUR
November 2017

What are ELSS Mutual Funds?

·                     ELSS (Equity Linked Savings Scheme) or Tax Saving Mutual Funds are the special funds which are meant for the purpose of tax saving under Sec.80 C of IT Act.
·                     Lock-in period of ELSS Funds is 3 years. This is the lowest lock-in period among all tax saving instruments you invest. However, each investment (monthly SIP) is considered as fresh investment. Hence, each investment or monthly SIP must complete 3 years for liquidating. Let us say, you started the monthly SIP on January 1, 2017, then the first SIP will be eligible for withdrawal after the completion of 3 years, i.e., after January 1, 2020. Similarly, February 1, 2017 SIP will be eligible for withdrawal after February 1, 2020. You have to wait for the completion of the fourth-year to completely withdraw the amount.
·                     ELSS falls under EEE tax rule (Exempt-Exempt-Exempt). There will be no tax during investment, no tax on whatever you earn and no tax at the time of withdrawal. This means the dividend declared from such funds are also tax-free in the hands of investors.
·                     The monthly investment required is as low as Rs.500. There is no maximum limit. But the maximum tax benefit under Sec.80C is Rs.1.50,000 as of now.

The most efficient tax-saving instrument…

Capital Appreciation - Like other equity mutual fund schemes, these mutual funds too are optimized for the highest returns possible. Just start an SIP in the right fund and rest assured that you grow your wealth over long term even without any significant effort on your part.
Tax Efficient - When compared with any other diversified equity mutual fund, the taxation on the gains are the same. So, what makes ELSS different from any other diversified mutual funds? You can invest up to Rs 1,50,000 in an ELSS and get that as a tax deduction under Section 80C in a financial year. When compared to other popular tax saving instruments such as Tax Saving Fixed Deposits or PPF, ELSS is definitely better. Not only does an ELSS reap higher returns, long-term gains from an ELSS are absolutely tax free just like that of PPF. Moreover, both the dividend incomes and capital gains earned from ELSS is tax free.
Shorter Lock-In Period - This is what makes ELSS better than all other investment options.
While your tax saving investments in PPF is locked in for 15 years, NSC for 6 years and tax saving bank fixed deposits for 5 years, your investments in ELSS is locked in for just 3 years. So, if you are looking for tax benefits along with higher return potential, but do not want to commit your money for very long period of 5 to 15 years, ELSS is something you should look for.
Efficient Fund Management - Unlike in a term deposit or a NSC, where you put your money in and the issuer just lends it out, while paying you a nominal return; a mutual fund is geared to grow your investment in a much more efficient way. Why? Because a mutual fund is expected to be managed by professional fund managers. They invest with an aim to make higher gains for their investors. Investing in a mutual fund is risky per se. But if you invest in the RIGHT mutual fund, you would reap much higher gain than you can probably expect from a fixed deposit, PPF account or savings certificate. 

…with rich returns

ELSS Funds have the potential to offer superior returns over a long period since they invest in stocks. ELSS Funds are managed with a multi-cap mandate and thus feature very wide variations in their style and market-cap orientation. This explains why the return divergence in the category is so high. Over the last ten years (as of March 16, 2017), the CAGR of the best-performing ELSS fund (Invesco India Tax Plan) was 16.54%, but that of the bottom one (Escorts Tax Plan) was 7.09%. Over the last five years, the category has delivered a decent 12.42% CAGR, helped by good performance from the mid- and small-cap pack from a low base. As the category tends to be quite volatile (thanks to the smaller stock allocations), SIP returns for the last five years, at 17.47%, are nearly the same as lump-sum returns. CRISIL’s rolling returns analysis shows that even though ELSS (represented by CRISIL-AMFI ELSS Fund performance index) have returned 24% CAGR, on an average, for a three-year holding period, investors can face the risk of short-term volatility. For instance, the rolling three-year period analysis shows that investors can face capital erosion (minimum returns of -11%) and high volatility (represented by standard deviation) of 20%. These risks reduce as investors increase their investment horizon to the long term, thus deriving optimum benefits. For instance, ELSS Funds have given 10-year rolling returns of 19% CAGR, on an average, with volatility reduced to 6% and minimum returns of 10%. This is still a fail-safe higher yield versus long-term inflation of around 7% and 8% by traditional instruments. Also, this is in sync with a young profile and long-term horizon for aggressive investors.

ELSS vs. Equity Funds

ELSS as a category has performed much better than Equity Mutual Funds. The average returns of ELSS and equity funds were 60% and 44% respectively for a three-year period and 145% and 116% respectively for a five-year period.

Normal equity funds do not have a lock-in, though there is an exit load. So fund managers are constantly making sure they have a liquid enough portfolio to meet redemption pressures if any. How is this different in ELSS? Since each cash flow has a lock-in of 3 years, what it does mean is that the fund manager can take long term calls on stocks and on the overall portfolio. It also means that the fund manager does not worry about meeting redemption pressures in the short run. Typically, you would see churn ratios (also called turnover ratio) being lower in ELSS as against large-cap funds. This is one of the main reasons that returns are a bit higher. The fund manager then can choose value stocks or growth stocks depending on his mandate of the fund. Holding period can be much higher in ELSS than usual equity funds.

Rising popularity, albeit a few concerns

ELSS has been gaining popularity over the years if the meteoric rise in assets under management is any indication. The category currently manages Rs 70,087 crore as of August 2017, up 18% on an annualised basis over the past decade compared with 16% growth for industry over the same period. Though ELSS funds have been gaining popularity with investors, most funds in the category are of a manoeuvrable size, with their average assets managed at Rs1,234 crore. This allows the schemes to fish for good bargains among small- and mid-cap stocks, without worrying about impact costs. You should invest only after considering your risk profile and conducting proper due diligence.

Need of the hour

ELSS funds are the best wealth creators among all the tax-saving avenues mentioned under Section 80C. It is the equity element that gives ELSS its unique wealth-creation abilities. So, invest in them only if you have a high risk-appetite to handle the volatility in the stock market. Though these schemes have a mandatory lock-in period of only three years, you should invest in them only if you have an investment horizon of five to seven years.  For a longer duration, any product which generates returns over and above inflation is good for the investor and in the category of tax-saving instruments, ELSS funds are the best of the lot till date. But are these funds always good for an investor? Does this fund suits every category of investor? Are these funds successful in generating good returns in the short term? Have you ever thought about these questions while investing or just invested because you need to save tax? You should avoid ELSS funds if you are looking for short term and are not comfortable with equities. However, you should also keep in mind that ELSS funds are not at all bad. In fact, ELSS is the best tax saving option available in India but only for those who are looking for long term investments and have the capacity to digest volatility.


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