7 Top Mutual Fund ELSS Schemes

Come January and investors will start planning for tax – it is a  common investment behavioural pattern observed in India. Investments aimed at saving taxes is one of the most important financial decision that any individual investor has to make on a regular basis. A right decision can lead to some enticing wealth creating opportunities.

Indeed sound financial planning is a precursor to sound tax planning. Ideally detailed tax planning should lead to the allocation of funds in various tax instruments. Tax paying investors most of the times are not sure what could be the best way to invest, in order to minimise the taxes and thus maximise individual gains.

One of the reasons for confusion is also the plenty of options available with investors  when it comes to tax savings, and within the several headline options availability of hundred different financial products, for e.g there are more than 176 ELSS mutual funds to choose from.

Once a sound financial plan allows for exposure to the equity linked savings plan, the most important decision rests with an individual investor to choose those specific tax savings instruments that will allow the wealth to be accumulated even as the tax saving criteria is being optimised.

ELSS is one of the most popular tax savings instrument, as it has the shortest lock-in-period in comparison to other investment products like Public Provident Fund (PPF) or National Savings Certificate (NSC).

Also the dividends declared in ELSS Funds are tax-free and there exists no tax on long-term capital gains. Needless to suggest that equity being the underlying instrument, the ELSS is on the higher side of risk compared to other instruments.
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Says Kaustubh Belapurkar, Director Research at Morningstar, “Equity Linked Savings Schemes, popularly known as ELSS have been gaining popularity with investors over the last few years. The Assets under Management (AuM) in ELSS Funds have grown from 19,300 crore (Dec’11) to 47,500 crore (Nov’16) over the last 5 years, registering a 147% growth.  Over the last one year itself 7500 crore of net inflows have come into these funds. ELSS Funds are one of the many options available, to avail of a deduction upto 1.5 lakhs under Section 80C of the Income Tax Act. Unlike many of the traditional options, which come with a return akin to fixed income and a longer lock-in, ELSS Funds offer the upside of equity, albeit with volatility in the short term and have only an enforced 3 year lock-in on the investment. These features have attracted investors to ELSS Funds.”

When it comes to clubbing investments and Tax efficiency together there is a possibility that an individual investor may get confused with the products on offer that focus on equity investments and yet provide a tax shelter. ULIP products and ELSS schemes offered by several of the fund houses are often seen as competing products and most of the times individual investors find it difficult to choose between the two.

Says Dinesh Rohira, CEO of 5nance.com,“ELSS schemes score the best in terms of offering better returns and a shorter lock-in period of three years without any regular investment commitments to be made. On the other hand, ULIPs provide you additional insurance cover mixed with the basic purpose of investments with a flexibility to choose the proportion of equity and debt component within the product. Investors can choose ULIPs for their structural advantage and ELSS Funds where they are looking for maximising the returns and creating wealth on a sustainable basis."[PAGE BREAK]

Picking the best performing ELSS

Choosing the right ELSS scheme to invest one’s hard earned money in is critical as it can make a huge difference to one’s portfolio as there is a remarkable gap in performance in the best and worst performing ELSS Funds in the category.

It is observed that any individual investor, while narrowing down on a mutual fund pick, normally makes an error by opting for the most recent chart topper, despite the bold disclaimers on past performance not necessarily being an indicator of future performance.

According to Kaustubh, “We are big believers of the fact that ELSS Funds should be treated as pure diversified equity funds, and would urge investors to look beyond just tax saving via these funds. The unconstrained style of these funds allows the manager to handle the portfolio to his inherent strengths and often reflects ideas of the manager that are of the highest conviction. These factors will result in long term outperformance.

ELSS Funds have done quite well over the last 5 years, with the category delivering 17.1% CAGR returns on an average, with a significant outperformance over the broader markets. (Sensex: 10.86%, BSE 500: 13.1%).”

He further adds, “Identifying a good manager with a solid strategy is crucial to picking a good ELSS Fund. Thus we urge investors to look for managers who have been consistent across market cycles, rather than picking them on pure performance. Ratings work as a good guide to pick funds. Star ratings often rate managers on longer dated risk adjusted returns, which can serve as a starting point for making an investment decision. Forward looking ratings are an important filter, as they delve into the strengths and the skill set of the manager, in addition to analysing the robustness of the investment process, which can help identify the manager and funds that are geared to deliver consistent longer term outperformance going forward.

Overall ELSS Funds offer an attractive opportunity not just for saving tax but also for long term wealth creation."

Beyond choosing the most appropriate ELSS fund it may be noted that regular investment has proved to be extremely important and beneficial for individual investors. Investors need to invest regularly to benefit from the volatility in the market through rupee-cost averaging.

Some Investors may argue that the logic of systematic investment plan as lump-sum investment may provide better returns in up market in the long run as the basic assumption is that the markets will be trading at higher levels in the long run.

The table below highlights the return differentials when one compares investment via lumpsum mode vs a Systematic Investment Plan. We see that the returns via lumpsum mode have been better when compared to the systematic investment route for the different time period considered.

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However the comparison may not factor in the additional risk one takes while investing in mutual funds via a lumpsum mode. There is a market timing risk that one takes while investing in markets via the lumpsum mode. Also there is an opportunity cost involved while investing in the lumpsum method as the capital gets blocked, which can be put to use for next best alternative.

Coming back to the question of selecting the best possible ELSS schemes, any investor should focus on the historical performance, no doubt along with the pedigree of the asset management company, but beyond that should also ask following key questions before selecting the right ELSS scheme –

• What is the fund strategy and whether the fund is large cap oriented or is it more concentrated on small cap etc.?

• Understand the reasons behind the good performance. For e.g It may be possible that fund manager by sheer luck or accident bought certain industry shares that turned out to be multi-baggers. Having a deeper look one may discover it to be a one-off incident.

• It is important to see how the fund has performed under the current fund manager. It is easy for the investor to look at returns and take an investment decision only to realise later that the star performer fund manager is no more looking after the fund one has invested in.

Identifying a good manager with a solid strategy is crucial to picking a good ELSS Fund.

Various Tax Savings Options

• ElSS tax savings Mutual Funds

• Public Provident Fund

• Tax Savings Bank FD schemes

• Senior Citizens Savings Schemes

• Rajiv Gandhi Equity Savings Scheme (RGESS)

• Voluntary Provident Fund

• New Pension Scheme

• National Savings certificate

• Unit Linked Insurance Plans

• Traditional Insurance Plans

Conclusion:- 

Holistic tax planning is most crucial as part of a broader financial plan. Any investment decision including the one for parking funds in tax saving instruments should be in conjunction with the entire portfolio.

While selecting a good performing tax saver fund, adequate attention should be given to all the aspects of the fund including the fund manager credentials, assets under management, historical track record, expense ratio etc.

Taking cues from developed markets where several of the advanced economies are witnessing negative interest rate environment, emerging markets including India may go through a phase where the interest rates remain low for a considerable time in the future. With interest rate expected to remain soft the traditional tax saving options like PPF, National Savings Certificate etc  are expected to not generate returns that may impress the investors.

Having said that the best period for equities to perform is when the interest rate cycle is pointing downwards. US markets with their ups and downs over the past 100 years have managed to deliver nine per cent annualised returns. Indian equity markets owing to their growth characteristics are expected to deliver 12 to 15 per cent on an annualised basis over the long term.

ELSS Funds if selected judiciously work in favour of investors, both ways, in terms of saving taxes and creating wealth in the long run. Investors need to have faith in the asset class that is equity, show good amount of patience and invest systematically maintaining discipline.

Mutual Funds in US markets or even other developed markets for that matter have struggled to outperform the benchmark index as measured by alpha which calculated the extent of excess returns generated by the fund.

Indian mutual funds thus far have been beating consistently the benchmark index and are able to generate good amount of alpha or excess returns. Investors should encash on such an outperformance and create wealth for themselves.

Exclusive Interviews

Mahesh Patil, Co-CIO, Birla Sun Life AMC

There is a strong case for Equity as an asset class to outperform other asset classes in the medium term (3 years and more) – which should be the ideal horizon of investing.

At an absolute level, in the last two years, equities have underperformed (considering Nifty Index), after a stupendous run up in 2013/14. The valuations are fair at current levels on various parameters like - Price to Earnings, Price to Book and Market cap to GDP basis. As earnings rebound in FY18 (after a brief setback in H2FY17) these ratios would start looking very attractive.

On a relative basis, the yield gap between equities and bonds presents a favourable scenario for equities. The interest rate on fixed deposits has moved down over the last one year and will further move down in the next few months as banks are awash with liquidity. Post demonetisation, real estate sector is seeing pricing pressure in primary market and also freezing of secondary market. While things will ease in the next few months, returns from the asset class would be capped.  Gold is also facing head winds in the form of strong US Dollar strength and inflation still being benign. Hence, for an investor choosing between Equities, Fixed Income, Fixed Deposit, Real Estate and Gold, Equities comparatively look attractive.

In the Emerging Market (EM) basket, most FIIs have been maintaining a strategic over weight position on India for the past 3-4 years. This is due to long term growth, which India offers at a reasonable price. This rationale is still intact. In 2016, some EM portfolios have moved towards the beta trade in commodity led countries due to the recovery of commodities. In 2017, as commodity prices stabilise and beta trade matures, India could be a beneficiary of additional flows.

India offers to its investors - growth, political stability, recognition of bad assets and sustainable reform processes due to which the strategic overweight position can continue. India has outperformed EMs by 10% p.a. for the last five years until end of 2015. It has under performed by 5% in 2016. This short term trend could reverse, bringing back the outperformance it has been showing against the EM basket.

Yes. It is true that FIIs have been taking some money off from emerging markets including India. Donald Trump will assume office in Jan’17 and there is an expectation that he would incur sizeable fiscal expenditure, which would increase growth. At the same time it could increase inflationary expectations because of which fed would increase rates by 75 bps in 2017. While most of it is factored in, there is still some room for USD to strengthen and hence can affect flows negatively for the next few months.

It is difficult and impossible to predict FII flows with accuracy on a yearly basis. However, as some of the developed markets are at elevated levels, and the reality of what the new President in US can do in terms of policy and fiscal stimulus sinks in, the flows could resume into EM, including India. If the investment thesis on India holds good as presented in the previous question, there is no doubt that India will be a disproportionate beneficiary. It is interesting and important to note that the counter balance to FII outflows has been the domestic inflows. The latter remains to be on a strong footing, providing support to the markets.

There are many triggers to watch out for domestically and internationally. The effect of demonetisation will be seen partly in quarterly numbers to be announced in Jan’17 (Q3 FY17) and fully in Apr’17 (Q4 FY17). Meanwhile high frequency data points would also give an indication of its impact on growth at the macro level. The budget in early Feb’17 will announce the growth measures, which the government could be taking.

2017 will also be a politically heavy year with important states like UP and Punjab going in for elections. This will set the tone for how much ground level support, the ruling coalition has. As mentioned in the previous question, hopes are riding high on what Donald Trump can deliver, which will be evaluated consistently. Europe would see elections in important countries like France, Netherlands and Germany. A far Right party forming a government in any of these countries could mean that there would be a referendum to exit the Euro zone and the European Monetary Union.

So, there are enough triggers which the market will be considering in the medium term both locally and internationally.[PAGE BREAK]

We believe that ELSS has many advantages, which makes it one of the most preferred option when the objective is to save tax and create wealth over the longer term, wherein lower lock-in period of three years & Tax free dividends in the hands of investors are few benefits of ELSS. With option of SIPs, one can resort to tax planning at the beginning of the financial year.

Also as a fund manager, the three-year lock-in allows investment decisions to be taken with a longer term outlook, as there would not be fears of redemption and it also allows capturing the benefits of the entire cycle playing out.

Over long periods of time, equity as an asset class has performed well in relation to other asset classes and we believe this will continue. In India, given the low interest rates, it does make for a strong case to increase allocation to equities as the potential returns over the next 3-5 years could be significantly higher.

What are the key risks underlying the equity markets in the coming quarters and effects of demonetisation on earnings growth in coming quarters in your view?

It seems fair to assume that growth would be adversely impacted for the next two quarters at least. The urban part may recover sooner; whereas the rural pain could last longer. Compared to earlier expectations that the worst impact would be felt in November and December, and that from thereon we would expect things to improve gradually with each passing month, we now expect the Jan-March quarter to be worse than the October – December quarter in terms of corporate results. Commodity prices have been rallying and 10-year yields of the US have risen from 1.8% to 2.6%, and these will put pressure on earnings going forward in addition to triggering some FII outflow. The most important issue is whether this entire exercise yields any fiscal space to the government to push social spending and public spending on infrastructure.[PAGE BREAK]

Equity Linked Savings Scheme or ELSS is a tax efficient form of investment which provides investors an opportunity for capital appreciation through exposure to equities. Most of the other tax saving products are primarily debt products like PPF and insurance.

I will not be able to comment about the future performance of the ELSS funds. In my view, Indian companies will continue to see earnings growth in line or higher than the nominal GDP and this should get reflected in equity prices.

The investor should essentially look at the long term track record of the fund, both in terms of returns and risks. While returns could be great, they should not be viewed in isolation. One should also see the amount of risk taken to generate those returns. Also, the investment approach and the portfolio of the fund  are extremely critical. One cannot ignore the expense ratio, that is, how much is it going to cost for an investor to invest in the fund. These things are important, as investors will not be able to withdraw money for the next three years after investing, thanks to the lock-in period which is a fundamental nature of an ELSS product

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Equity Linked Savings Schemes are the best possible investments for the retail investor. You get not only tax saving benefit, but also get superior returns. Also, remember that you get optimum returns from equity only if you remain invested for long. Most retail investors who fail to make money after investing in good equity mutual funds do so because they do not remain invested long enough and succumb to a nervous sell-off due to equity market volatility (equity being the most volatile asset class). The three-year lock-in ensures that the investor does not succumb to nervousness due to market volatility and redeem prematurely, thus saving them from their own behavioural bias.

Yes, definitely. Equity as an asset class can deliver 12-15 per cent returns over the long term. A well-run mutual fund can easily do better than that. I think as the market conditions improve – and they are bound to improve – the low returns in the last five years and the law of averages catching up, the returns will only improve over the next five years.

While we are seeing an increasing number of investors in our ELSS scheme, the number is still far below the potential that exists for a long term savings and investment product with superior risk-adjusted returns. Competing products like the ULIPs tend to attract far superior flows. The potential for ELSS schemes is enormous and I remain hopeful that they will eventually become the primary pool of savings and investment for retail investors in the country.

We had a modest NFO in January 2015 and closed 2015 with around Rs 100 crore in AUM. Since then we have more than doubled the AUM which stands at Rs 210 crore as of  now. This entire period market returns have been flat to slightly negative while the fund has delivered mid-double digit returns.

One should look at the following factors while choosing an ELSS scheme: Whether the fund house has a long term orientation towards investing backed by a coherent investment process; whether the management style is conservative (reflected in higher risk-adjusted returns) and quality and track record of the fund management team.

Equity in a growing economy like India remains the best long term asset class. Assuming the nominal economic growth is 10-12 per cent over the next decade, corporate earnings should grow slightly faster at 12-15 per cent. Over the long run (a decade or more), equity market returns strongly mirror corporate earnings growth. Hence, long term returns should range between 12-15 per cent. This is assuming that the inflation remains low at 5-6 per cent on an average, with the risk-free rate being similar.

Due to the massive sell-off by the FIIs since demonetization and the Trump election win in the US (the two events coincided), we have already seen a good correction in equity markets with correction having been sharper in stocks which had higher PE ratios and were over-owned by FIIs. Now, valuations across the board have become reasonable, hence the room for correction is limited. Continued FII selling, while DIIs increase their buying, will lead to a range-bound market for the coming quarter. The market should rebound as soon as FII selling pressure eases.