The Best 5 Tax Saving Mutual Funds

In her thirties, Chandrani Kaithal has just few weeks in hand to submit documents related to investments made by her during the financial year passing by to the accounts team of the corporate she has been working for in Mumbai. She has a home loan commitment, she also has made investments in various life and medical insurance products and Kaithal had earlier opened a PPF account with one of the PSU banks a year back to make wise investments and save on taxes. This morning a discussion over tax savings with a journalist friend has been an eye-opener for this resident of Borivali. She should have made investments in Equity Linked Savings Scheme (ELSS), something which she missed till now. There are many Kaithals who tend to forget existence of ELSS or tax saving mutual funds while making their investment decisions.

In this issue of your favourite periodical, we thought of talking exhaustively on ELSS and how they can really be a good investment decision. For many tax-payers, who are yet to exhaust their entire limits of investments under section 80C of Income Tax Act 1961, ELSS or tax saving mutual funds, remains one of the best options compared to other instruments under provisions of section 80C. Although, there is a complete range of tax saving instruments available to them, in Dalal Street Investment Journal, we believe ELSS scores higher over other options when it comes to tax saving. “ELSS in fact, provides a number of benefits unlike most other such instruments in this segment. The return on investments can be higher and it helps to save on tax liabilities hovering your head,” says Saurin Shah, an investment consultant in Ahmedabad. During the last quarter of the current fiscal, Shah has been asking his clients to put in money in various ELSS products available in the markets to get a strong return over a period of time and also save significantly on tax payments. “I never thought it could help me on saving my taxes. Earlier I had this idea that ELSS investment may be riskier and so I thought of playing safe with other products like PPF and NSC till I was shown a chart of comparison by Shah, I never thought of getting into ELSS,” says Shrenik Mehta, an executive with a top corporate. Mehta, as he puts in words, an ELSS fan. So why ELSS is being talked about when we have an entire gamut of instruments available that will have tax saving benefits also available u/s80c-  like Public Provident Fund (PPF), National Savings Certificate (NSC), Unit Linked Insurance Plan (ULIP), etc.- “the benefit of ELSS funds is that it provides the best of both worlds i.e. tax savings and investment. The likes of PPF, NSC and others carry lower risk, however comes with lower coupon/interest rates, with which one ends up with lower returns on their investment as compared to ELSS in the long run,” said a financial consultant based in Mumbai.  

How does it work then in simple terms-- say you invested Rs 1 lakh each in NSC certificates and an ELSS scheme five years back in 2011 and in such a situation, your money would have grown to Rs 1,46,933 assuming 8 per cent of annualised rate in NSC. In case of ELSS, your money would have multiplied to Rs 1,68,896 at a rate of 13.96 per cent (annualised average ELSS category return) during the same period. Although, this may not look exciting because in between there were two years when overall equity markets gave negative returns. Nonetheless, it has remained one of the best performers in its class.

“ELSS is highly suited for the set of people who are sceptical about equity investment but at the same time, they wish to feel the Casino Effect of this kind of investments,” Mehta said while sharing his experiences and exposure in ELSS during last two years. From a behavioural finance perspective, ELSS makes good initial move to equity investing and of mutual funds. Investor tuned to ELSS may end up investing in these funds because the tax-savings attracts him and it has the shortest lock-in condition in its category. As equity market generally fetches good return in longer term, one can expect good returns after a period of three years which will certainly encourage the investor to channelise his saving towards mutual fund investment, even if some of them do not offer the tax benefit. So choose carefully and read between the lines, advises Shah.
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Following are few other reasons that help ELSS funds stand out from other tax saving avenues:

1. Lock-in period of three years for ELSS funds is much lower than the six years and 15 years of lock-in period in case of NSC and PPF instruments respectively.

2. The dividend in the hands of investors is tax free even before the lock-in period is over that is as and when the scheme declares dividend. While in majority of other instruments, the interest on the investment is taxable and is received on maturity.

3. Gains arising out of ELSS funds are considered to be of long-term and hence tax-free. While the gains arising out of tax saving debt instruments are liable to pay long-term capital gain tax. Resulting in higher post tax return in case of ELSS.

4. Investment in ELSS funds after three years becomes self-sustaining (assuming they do not lose money) making it more liquid as against other products.

Considering one’s risk profile, investors can select one or more schemes from the list of five funds that we have cherry picked. However, investors should select not more than three schemes, as tracking performance and churning of portfolio, post the lock-in period, may become a hectic and time-consuming affair. Moreover you will not get the desired diversification benefit beyond three schemes.  We also suggest you to avoid any last minute rush and after estimating the amount you want to invest in ELSS, divide it by number of months and start an SIP.

For the best way to choose ELSS funds, one should plan ahead and not wake up to tax-saving investments late in the year. For a variety of reasons, savers tend to make hasty and poor decisions while choosing their tax-saving investments. That's also the way to avoid any last minute rush. At the beginning of every year, estimate the amount you have left over from the Rs 1.5 lakh limit after statutory deductions, divide it by 12 and start an SIP.

Review of 2013 Portfolio

As ELSS has a lock-in period of three years, it does not make sense to review last year’s recommendation as it will only give you notional profit or loss. Therefore, in this issue we are reviewing the recommendation we gave three years back in year 2013 (Five Best Tax Saving MF Schemes, DSIJ Vol. 28, Issue Number 5, dated Feb 11 - 24, 2013).

The average return generated by our recommendation was 75 per cent (after adjusting for the dividends paid in last three years) compared to 32 per cent given by BSE Sensex in the same time. If we annualised them, it comes to around 32.28 per cent, more than any other options available under Section 80C and what has been achieved by the Sensex in last three years. If we include the tax advantage one availed in the year of investment, the yield will improve further depending upon the investment made and tax slab at which they belong.   What is also important to note is that all the five recommendation made by us have outperformed the frontline indices by huge margin.  

Methodology – Fund Selection

Once again we have used the data and concept jointly developed by TheFundoo.com to arrive at best equity linked saving scheme (ELSS) funds.  We believe that this methodology identifies funds that shall deliver better risk adjusted returns consistently. We first filtered funds that had completed three years since inception and had an AUM of over Rs 100 crore. Then we analysed the fund performance vis-a-vis category peers across four different parameters namely.  Returns that is analysed and graded over different time frames, that is three years, two years, one years and six months. Risk is compared on the basis of standard deviation of the funds, style based on Jensen’s Alpha and finally the consistency factor was compared where we graded funds based on consistency of alpha generation, sector allocation and stock selection and alpha over its benchmark. All these parameters were bucketed and then they were given appropriate weightage to arrive at the list of five best ELSS funds.
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Funds Write Up

Axis Long Term Equity Fund has appeared in our recommendation list for the third time in last four years. This itself speaks a lot about the fund’s esteem.  The fund has consistently outperformed its peers since inception and has remained among the top performer among its category. In the three year ending December 29, 2015, the fund has generated a return of 27.32 per cent against 17.77 per cent by the category. Considering shorter term returns, say in last one year when in general the market has literally moved nowhere, the fund has generated return of 7.62 per cent compared to category return of 4.08 per cent while its benchmark BSE 200 has generated a negative return of one per cent in the same period. Such performance has not come by sacrificing the risk factor.  The fund has been able to generate alpha (A risk-adjusted performance measure that represents the average return on a portfolio over and above the theoretical return) of 14.47 while keeping its beta, which in a way represents riskiness, lower at 0.87 at the end of November 2015.

The factor that has helped the fund to outperform is the prudent investment strategy adopted by the fund manager. The fund manager, Jinesh Gopani, largely follows a bottom approach for stock selection and invests in a diversified portfolio with focus on growth companies that are mainly blue chips or that comes under large caps. Though the fund has the flexibility of investing across the market capitalization spectrum that is small, mid and large cap companies, it has maintained a judicious mix of mid and large cap companies to deliver superior returns for its investors. At the end of November 2015, large cap constitutes 56.4 per cent of the total portfolio while mid cap companies constitute 25.9 per cent.

The fund has a very concentrated portfolio of just 36 stocks at the end of November 2015. This shows the conviction of the fund manager in the stocks he is investing in. Detail analysis of portfolio shows that stock picking ability of the fund manager has been right for 59 per cent of time in last two years. 41 per cent of the time when he has gone wrong, those stocks have not generated large negative returns and hence did not impacted the returns much.

Top 10 stocks cover majority of the portfolio and at the end of November it constitutes 51 per cent of the total portfolio. Sector wise weightage of fund also reflects the concentration of investment. Top two sectors alone constitute 43 per cent of total portfolio. The fund does not take cash calls and 98 per cent of the assets remain invested in equity.

Considering the funds and fund manager’s performance over the years, and its concentrated asset allocation strategy, investors with moderate to high risk taking ability can take exposure in this fund.

Birla Sun Life Tax Relief 96, one of the oldest funds in the ELSS category seems to be getting better with the time. The fund has been able to beat its category return in all the time frame whether it is 10 year or in last one month. Since its launch in March 1996, fund has generated annualised return of almost 26.5 per cent. Although the average performance over the years has remained strong there are some years such as 2005, 2008 and 2011 when it has remained at the lower quartile of the performance only to return a strong performer in the subsequent years.

The reason for strong performance is due to better investment strategy as explained by Mahesh Patil, Co-Chief Investment Officer, Birla Sun Life Mutual Fund, “it follows a combination of the top down approach and bottom up approach in the stock selection process. The top down approach will focus on an analysis of macroeconomic factors, economic changes & trends, key policy changes, infrastructure spending, etc. The bottom-up approach would seek to identify companies with high profitability and scalability supported by sustainable competitive advantage.” Fund invests into companies which are reasonably valued and have high growth potential and generally refrains from investing in companies which have high debt on their books and companies which fail to make efficient use of cash.

What differentiates this fund from others in this category and which has led to such performance of the fund is large allocation of the funds-it has allocated 41 per cent of the entire portfolio to mid cap stocks compared to 13 per cent by benchmark and 29.31 per cent by category. As we know mid cap remained the star of 2015 beating frontline indices by huge margin, helped the fund to outperform others.

In addition to this, right sectors’ allocation too helped the fund to outperform. On the sector allocation front, being over-weight in automobiles, industrial manufacturing and fertilisers and underweight in financial services and energy helped in contributing to the outperformance. The fund is event agnostic and positions itself by investing in quality stocks thereby restricting the impact of any adverse major global or local event. The astute stock picks and a timely move across market-caps has helped the fund to outperform in last year.

Looking at the consistent performance of the fund over the years along with its asset allocation strategy investors with investment horizon beyond the lock-in period of such funds should invest in the fund.

Tata Long Term Equity Fund

The year 2015 has been a year of small and mid-cap companies. In last one year, the stock of these companies spurred the most on the bourses. While frontline indices such as Nifty and Sensex have given negative to flat returns last year, mid-cap has given returns in higher single digit. Funds that were quite agile their asset allocations in 2015 have outperformed. Tata Long Term Equity Fund remains one of such funds that has made tactical asset allocations across market-cap and especially towards mid and small cap stocks. Historically, the fund has maintained three fourth of its portfolio in large-cap stocks, with mid caps making up the rest. But in the last couple of years, large caps have been trimmed to below 60 per cent with rising mid-cap exposure. This strategy has helped it to outperform the category by 915 basis points on YTD basis. Even in other time frames including 10 years, the fund has been able to beat its category, however, better part of the return has come in recent years. For example, in last one year the fund has given return of 7.04 per cent compared to flat return by category in the same period. 

“The performance of the fund can be primarily attributed to its focus on buying good quality businesses which have compounding characteristics, strong growth potential, good capital efficiency and are run by competent management teams. At the same time, some of the opportunistic exposure to special situations arising out of market, industry or stock specific developments have also positively contributed to the performance of the fund”, explains, Rupesh Patel, Fund Manager, Tata Mutual Fund.  The present portfolio is aligned to current market dynamics and focuses on stocks with strong fundamentals and high earnings visibility.
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Going deep into the stock selection strategy, fund primarily invests in those companies which have compounding characteristics, strong growth potential, high capital efficiency and good management teams. These companies tend to create wealth for its shareholders. These form the core of the fund’s portfolio. Beyond this fund also look at tactical opportunities which materialize because of market specific, industry specific or company specific developments. According to Rupesh Patel, the fund is currently “positive on consumer discretionary plays like automobiles, building materials etc. as decline in inflation, interest rates, implementation of 7th pay commission recommendations and improvement in sentiments on account of better job environment are some of the positives for the sector.” We believe that these factors will play out in 2016 and will help fund to outperform its peers.

Considering the fact that the fund has generated 20.32 per cent of annualised returns since its inception and agile asset allocation, long-term investors can invest in this fund through SIP.

This is a fund that does not follow the conventional wisdom of concentrating major chunk of its portfolio in large cap stocks. This strategy has its own advantages and disadvantages. For example, you may not have received consistent returns, however, better part is few years of outperformance may cover up the lost ground and some more. In last 10 year ending 2015, the fund has under-performed its benchmark three years. However, couple of years of outperformance by huge margin has helped the fund to remain in the top quartile of performers in long run. The fund has parked almost 60 per cent of its portfolio in small and mid cap stocks. Although, it is lower than what it used to be one -year back, it is still higher compared to its category, which invests on an average nearly 35 per cent on small and mid cap stocks. This has helped fund to beat its category return in long term, though, in some year it may have lagged.

In the last three years the fund has generated an annual return of 22.52 per cent as against 17.68 per cent generated by the category and 10.45 per cent by its benchmark, BSE 100. The reasons attributed for such performance as explained by Ashwani Kumar, Sr. Fund Manager, Reliance Capital Asset Management, is “fund has invested in high quality growth companies which have delivered strong corporate performance in last 3 years.”  Going ahead, Ashwani Kumar, elucidated that “fund is betting sectors which will benefit from domestic economic growth, the sectors are Autos, Auto Components, Capital goods and urban consumption oriented sectors.”

The stock picking strategy adopted by the fund manager clearly favours those companies “with strong growth outlook and managed by ethical managements” explains, Ashani Kumar. Though the fund has generated good returns and remained a top performer in the long term, looking at the portfolio construction we believe that this fund is suitable only for aggressive investors with a higher risk appetite and with slightly longer-term investment horizon.

There are opportunities everywhere, you just need to be vigilant to identify and exploit them. Last year we saw most of the large cap dedicated funds did not do quite well and underperformed the broader market. Nevertheless, BNP Paribas Long Term Equity fund, despite having three fourth of its portfolio invested in large cap stocks outperformed its category and benchmark in last one year by huge margin. The reason explained by Shreyash Devalkar, Fund Manager – Equities, BNP Paribas Mutual Fund is that ‘it is companies that create wealth, not markets.’ The companies are thoroughly researched internally by our experienced research team with an aim of ensuring that only the most suitable companies make it to our portfolio. Our investment philosophy of focusing on BMV (Business – Management – Valuations) framework for selection of companies in portfolio, has helped in consistent performance.  He further added, “in our opinion, the diversified funds having good mix of both large caps and mid caps companies tend to perform better since opportunities exists across market capitalisation.”

In last one-year the fund generated a return of 8.15 per cent compared to 4.08 per cent by the category. When we take longer time duration of three years and five years, the fund has beaten its category by 310 basis points and 469 basis points respectively. The credit for such performance goes to the fund manager Shreyas Devalker, who has been managing the fund since March 2011. There has been a marked change in the performance of the fund post 2011 and the way fund is being managed. The fund follows the philosophy of selecting those stocks that provides growth at reasonable price (GARP). Further every company’s business’s fundamentals are analyzed based on different parameters like secular trends, uniqueness of business model, moat of business etc. Management’s execution capability remains the key point in delivering sustained returns within the realm of industry dynamics. Corporate governance too remains one of the most important parameters before adding any company to the investment universe.

Going ahead, the fund manager believes that after a disappointing 2015, this year, that is 2016 will be different. There will be a transmission of the macro improvement to a micro level. There will be select sectors where earnings growth will pick up in a robust way. The sectors that fund is currently bullish on are those that will benefit from the rising middle class segment and its rising per capita income such as private sector banks followed by telecom sector, pharmaceuticals, consumers’ products, auto (including transportation), select NBFCs, media and cement. Such a defensive and growth oriented portfolio must form part of investors with low risk appetite

Now that you have read this and also got to hear what the experts and the top fund managers of India say about each of these five ELSS products, we understand its time you talk to your investment consultant and pick up the one suits you the most, this January. After all, only two months from now  the current financial year ends.