FUND FLAVOUR - NOVEMBER 2008

FUND FLAVOUR

Equity Linked Savings Scheme (ELSS)

A boon blossoming from the boom…

A booming stock market (till December 2007) coupled with relaxations in the overall investment limits for ELSS funds eligible for tax breaks over the past three years have prompted investors to allocate larger sums to equity linked tax saving schemes floated by mutual funds. Assets managed by ELSS mutual funds have grown nine-fold between April 2005 and March 2008, from a minuscule Rs 1,727 crore to Rs 16,000 crore. While there have not been too many new launches in this space, established ELSS funds, which have topped the return charts over the past three years have been the ones to see substantial inflows. These funds have managed to generate an astounding return of 41.30 per cent per annum in the last five years (as on June 2, 2008). While the equity-linked funds have gained popularity, thanks to the relatively shorter lock-in period, collections under small savings avenues such as the National Savings Certificates have seen a decline in recent times. In 2004-05, total collections under NSC stood at Rs 10,097 crore. But these stood at only Rs 3,628 crore in the first nine months (until December 2007) of 2007-2008, as per the data provided by the Accountant-General, Posts and Telegraph.

The ban(e) bombarding from the bust…

The market meltdown in the past ten months has raised a question as to whether the investors should opt for the Equity Linked Savings Scheme (ELSS) of mutual funds or take a mix of fixed income tax saving investments and diversified mutual funds that would provide them with some flexibility even while offering tax benefits. The question has arisen because of the steep decline in the value of equity linked savings schemes which come with a lock in period of three years, thus blocking the exit route for the investors in any falling market before the mandatory three year period is served. It is true that it is not only the ELSS but the diversified mutual funds which have taken the stick in the sharp fall the market has witnessed in the past ten months - from a high of more than 21,000 points of BSE Sensex in January to around 10000 now. But the sustained market volatility has led to a huge fall in the NAV of ELSS of even established fund players with proven track record. The rising interest rates of bank deposits and the fact that diversified equity funds offer the flexibility of cashing out in a falling market without worrying about lock-in period have further eroded the NAV of ELSS Funds.

A look at the data published by Value Research in a recent issue of ‘Mutual Fund Insight’ shows that the returns from Tax Planning Equity Funds has sharply come down not only on a one year basis but on a three year basis as well, which should be of concern. The inconsistency in performance of fund houses is also visible and some of the funds that figure prominently in five year category of top performing funds do not find a place in the next two categories – three years or one year. The wild swing in performance can be attributed to government policies and business environment of a particular sector and valuations at which stocks are purchased by a mutual fund also have an important role to play. If some funds had invested in power, capital goods and engineering, and real estate sectors some 10 months back, they would have underperformed as valuations in this space have been de-rated considerably whereas funds with greater exposure to IT and/or pharma would have given better yield than their peers. ELSS funds invest across all sectors because of the flexi cap mandate. Funds which could do relatively better did so due to better stock picking capability and probably higher concentration (in) specific stocks.

Will the market turmoil lead to investors having a re-look at their ELSS investment options? Considering the current valuations and potential over the next 3-5 years, staying away from equities carries a greater risk than staying with it.

A more rewarding option......to help finance your future

Come March 31 and you will, like every year, find people running around, looking to invest in tax-saving instruments. Most choose the regular ELSS (equity-linked saving scheme) instruments that have a three-year lock-in period as it gets them tax benefits under Section 80C. But this year, there have been some interesting options. Mutual fund houses have launched products similar to the usual ELSS, but with a much longer tenure of 10 years. What is more, since these are new funds, they come with the added advantage of having no entry load, unlike existing funds which carry an entry load of 2.25 per cent.

Nuggets to gnaw at…

By keeping a few strategies in mind, you can make the most of your ELSS investment.

Keep financial goals in mind: Every ELSS adopts different stock picking strategies. Some schemes such as Franklin India Tax Shield maintain a large-cap focus and are suitable for those who have a lower risk profile. On the other hand, funds that have greater exposure to small- and mid-cap stocks, such as Principal Tax Savings Fund, fit the portfolio of those willing to take a higher degree of risk. Ignoring this aspect would lead to a mismatch between the fund and your profile.

Diversify among styles: The role of the ELSS in a portfolio is restricted to providing tax benefits without compromising on the return. It cannot form the core of a portfolio. A portfolio should ideally stick to at best two schemes with varying investment styles and market focus.

ELSS & SIP – A Perfect Match : The first option gives you twin benefits of tax savings and capital gains. The next option helps you take advantage of fluctuations in the stock market and averages your cost of investment. What more does one need? However, remember that each instalment will be subject to a 3-year lock-in. So, if you enroll in a 3-year SIP and invest systematically every month for three years, you will get your entire proceeds only after six years, after your last instalment (at the end of the third year) completes three years.

Growth or dividend option: Choosing the growth option ensures compounding and capital appreciation in a mutual fund investment. However, in the case of an ELSS, the dividend payout option provides a degree of liquidity even during the lock-in period. The dividend paid out can be invested in other investment options, whether equity or debt, depending upon the rebalancing needs of the investor's portfolio and, thereby, reduce the risk in the overall investment plan. From the tax perspective, both options are equally efficient.

Do not chase NFOs: A new fund does not offer a track record to bank on. Populating your portfolio with ELSS NFOs every year is a mistake.

Buy from the company: Why pay Rs 2.25 entry load on every Rs 100 you invest to the agent ? Go to the fund office and buy.

See the whole to avoid the hole…

ELSS should be treated as part of the overall portfolio and not merely as a tax-saving instrument. This will ensure that all your investments will be as per your risk profile. Moreover, it will be goal oriented and not for the temporary purpose of saving tax only. You get returns from the equity market only when you have a long time horizon. If you keep adding money in a disciplined manner, you create a good corpus. It is indeed a good option to save tax and create long-term wealth with ELSS.