The January to March quarter of any financial year is crucial for mutual fund distributors and intermediaries of financial products and services. Receiving calls from mutual fund distributors/investment agents/relationship managers pestering you to invest in some or the other tax-saving investment products is a very common affair around this time of the year.

As you may know, there are galore of tax saving instruments available viz. Public Provident Fund (PPF), National Savings Certificate (NSC), Post Office Monthly Income Scheme (POMIS), Senior Citizen Savings Scheme (SCCS), National Pension System (NPS), endowment plans, Unit-linked Insurance Plans (ULIPs), 5-year Tax Saver DepositsEquity Linked Savings Schemes (ELSS)and many more. But if you are looking to get two birds in one stone, i.e. tax planning and potentially effective wealth creation that counters inflation efficiently, then ELSS is a worthy option amongst all the tax-saving investment avenues.

For those who are new to investing, an ELSS scheme is…

  • An equity-oriented mutual fund scheme that invests at least 80% of its total assets in equity and equity-related instruments in accordance with the equity-linked savings scheme, 2005, as notified by the Ministry of Finance
  • It has a mandatory lock-in period of three years
  • And helps you avail tax deduction of up to Rs 1.5 lakh per financial year under Section 80C of the Income Tax Act, 1961

I was expecting the Budget 2022-23 to iron out the tax disparity between ELSS and ULIPs, but unfortunately, the major concern of the mutual fund industry of treating ELSS at par with ULIPs for the taxation purpose wasn’t addressed by the Finance Minister Ms Nirmala Sitharaman.

Nevertheless, ELSS remains the most sought-after tax saving avenue, particularly amongst risk-takers. The Assets Under Management (AUM) of ELSS has grown over the last several years and today stand at Rs 1.49 lakh crore with over 1.3 crore folios as of December 31, 2021. The two key reasons for this is investors are taking a calculated risk to earn better real returns (also known as inflation-adjusted returns), plus are encouraged by the fact that ELSS, compared to some of the traditional investment avenues that have a longer maturity and lock-in period of 5 to 15 years, has the least lock-in period of 3 years.

Lock-in in the case of ELSS means you cannot redeem your investments before the completion of three years from the date of your investment. That said, this also calls for enough care and prudence when selecting ELSS or tax saving mutual funds for your portfolio.

Do not just invest in any ELSS or tax-saving mutual fund scheme just because the Indian equity markets are down 7%-8% from their all-time highs. Understand their portfolio characteristics i.e. the top-10 holdings, top-5 sector exposure, how concentrated/diversified the portfolio is, the market capitalisation bias, the style of investing — value, growth, or blend — and the portfolio turnover. Also, evaluate the fund management team assessing parameters like the fund manager’s experience, the number of schemes he/she manages, the track record of these schemes, the experience of the research team. Similarly, assess the efficiency of the mutual fund house in managing the investors’ hard-earned money i.e. the proportion of AUM actually performing and the overall investment process and systems followed by the fund house. This will help you get a sense of the qualitative aspect of the ELSS or tax-saving mutual fund scheme.

Speaking about the quantitative aspect, always assess, do not simply compare the returns across periods (6-month, 1-year, 2 years, 3 years, 5 years, 10 years, and since inception) but weigh how they have fared across market phases (bulls and bears) to judge how consistent the ELSS has been on generating returns. Further, do not merely look at the returns in isolation but also consider the risk (denoted by the standard deviation) the ELSS exposed its investors. To gauge the risk-adjusted returns, see where the ELSS is on the Sharpe Ratio, named after William F. Sharpe. As a general rule, the higher the Sharpe Ratio of the market-linked security, the better it is.

You see, such a holistic research-based approach is necessary given that ELSS is subject to the lock-in; because if you go wrong in the scheme selection, there is no way you could exit before the lock-in period from the date of investment ends.

How has been the performance of ELSS?

We analyzed 37 open-ended ELSS schemes that were operational as of December 31, 2021. They collectively managed an Asset Under Management (AUM) of Rs 1.49 lakh crore. The top-10 schemes on AUM accounted for around Rs 1.19 crore, i.e. over 82% of the AUM …and the revelations are shocking.

Table 1: Divergence in the performance in the ELSS category

Absolute Returns (%) CAGR Returns (%)
1 Year 2 Years 3 Years 5 Years 7 Years
Returns generated by the top performer 58.9 59.8 39.9 26.3 22.5
Returns generated by the bottom performer 7.8 13.0 12.1 9.4 7.7
Category Average Returns 25.8 24.9 20.8 16.1 13.2
NIFTY 500 – TRI 24.1 25.0 19.9 16.1 12.6

Data as of February 4, 2022
(Source: ACE MF, PersonalFN Research) 

As you can see in table 1, the range of returns generated by ELSS schemes has been extremely wide-ranging. In other words, not all ELSS have been able to generate appealing returns. The category average returns might be good for the benchmarking purpose but appears skewed because of the outliers –only a few select schemes have clocked really appealing returns for investors.

If the quantum of AUM is the test of popularity, some popular ELSS schemes such as Aditya Birla Sun Life Tax Relief ’96Nippon India Tax Saver (ELSS) FundHDFC Taxsaver and SBI Long Term Equity Fund have underperformed Nifty 500-Total Return Index and the category average of ELSS over the last three years.

Table 2: Long-term performance of ELSS with large AUM base

Scheme Name AUM (Rs in Cr) 3-year returns CAGR (%)
Axis Long Term Equity Fund 33,785 21.0
Aditya Birla SL Tax Relief ’96 14,463 12.1
Nippon India Tax Saver (ELSS) Fund 12,024 15.5
SBI Long Term Equity Fund 10,912 18.8
Mirae Asset Tax Saver Fund 10,660 25.7
ICICI Pru LT Equity Fund (Tax Saving) 9,965 20.7
DSP Tax Saver Fund 9,636 24.5
HDFC TaxSaver 9,402 15.5
Franklin India Taxshield 5,000 19.2
L&T Tax Advt Fund 3,575 17.1
Category Average Returns 20.8
NIFTY 500 – TRI 19.9

AUM data as of December 31, 2021
Data as of February 04, 2022
(Source: ACE MF, PersonalFN Research) 

Unlike those of other equity schemes, fund managers of ELSS schemes usually don’t face regular redemption pressure because of mandatory lock-in of 3 years. Despite this offering relatively better flexibility, ELSS with large AUMs seem to have faltered due to underperformance of its underlying portfolio, of course, but also due to their massive scale of operation.

Sectors that have performed well over the last two years such as IT, high-tech, real estate, metals and public sector banks amongst others, didn’t see early participation from many of these large-AUM funds. Aditya Birla Sun Life Tax Relief ’96 has underperformed remarkably, especially over the last two years due to its stock selection and sectoral calls. The fund held 13.2% of its portfolio in pharma stocks as per its December 2021 portfolio, a sector that hasn’t participated in the ongoing bull market barring the initial phase of the pandemic. Its exposure to FMCG and consumer durable segments has dragged the portfolio return over the last 2 years.

Speaking of HDFC Taxsaver, although its performance has improved considerably in the last one year, it still remains an underperformer on other important timeframes. Its bets on index-heavy value stocks and old-economy Public Sector Undertakings (PSUs) is one of the reasons for its performance to lag compared to some of its peers that have fared better.

Similarly, the SBI Long term Equity Fund’s predisposition to holding private sector banks along with its exposure to pharma and auto resulted in a mediocre performance of the fund. It is only recently that the private sector banks and auto companies have started participating in the broader market rallies.

On other hand, some lesser-known funds such as Quant Tax PlanBOI AXA Tax Advantage, and PGIM India ELSS Tax Saver Fund have outperformed their peers in addition to outperforming the Nifty-500 TRI across timeframes. Their relatively small asset bases helped them remain nimble across market phases.

The Quant Tax Plan, for instance, didn’t shy away from betting aggressively on growth-oriented mid and small caps when the valuations were attractive at the beginning of the pandemic. However, as the valuation gap between mid-caps and large-caps reduced due to the market rally, the fund trimmed its exposure to mid-sized companies and increased the weightage to large-caps. It is noteworthy that the AUM of Quant Tax Plan has gone up 13 times in 2021.

Table 3: Are these consistent outperformers?

Scheme Name Absolute Returns (%) CAGR Returns (%)
AUM (Rs crore) 1 Year 2 Years 3 Years 5 Years 7 Years
Quant Tax Plan 658 58.9 59.8 39.9 26.3 22.5
BOI AXA Tax Advantage Fund 552 31.5 32.2 29.7 21.1 16.1
IDFC Tax Advt(ELSS) Fund 3,533 40.4 34.9 25.8 19.8 16.0
Mirae Asset Tax Saver Fund 10,660 26.8 30.6 25.7 21.6
Canara Rob Equity Tax Saver Fund 3,098 24.7 30.2 24.9 20.3 14.8
DSP Tax Saver Fund 9,636 29.3 27.2 24.5 17.1 15.6
JM Tax Gain Fund 66 23.4 24.2 23.0 18.2 14.8
PGIM India ELSS Tax Saver Fund 342 32.8 30.6 22.9 18.3
Kotak Tax Saver Fund 2,418 29.4 24.6 22.8 17.1 14.3
UTI LT Equity Fund (Tax Saving) 3,038 26.0 26.5 22.8 16.4 13.0
Category Average Returns 25.8 24.9 20.8 16.1 13.2
NIFTY 500 – TRI 24.1 25.0 19.9 16.1 12.6

Data as of February 4, 2022
(Source: ACE MF, PersonalFN Research) 

ELSS funds such as DSP Tax Saver FundCanara Robeco Equity Tax SaverIDFC Tax Advantage (ELSS) Fund, and Kotak Tax Saver Fund are some of the other schemes in the ELSS category that have done well on 3-year, 5-year, and 7-year timeframes.

The Canara Robeco Equity Tax Saver followed a balanced approach and invested across market caps and investment themes, although its portfolio has predominant exposure to large-caps. The same holds for DSP Tax Saver.

All the aforesaid instances suggest that the popularity of an ELSS shouldn’t be construed as an indicator of its performance. While it’s true that consistent outperformance leads to popularity, it would be wrong to conclude that the popular funds are consistent always. The returns on the ELSS or tax-saving mutual fund scheme will depend on the quality of its underlying portfolio and how the market performs. Therefore, do not get swayed away by the popularity of a fund today or its star rating.

Here are seven common mistakes you should avoid when investing in ELSS.

To guide you select the best ELSS for your portfolio, PersonalFN will be releasing its Money Simplified Guide — “Your Definitive Guide to Select ELSS [2022 Edition]” in the first week of March 2022, so watch out for this space.

Given that the Indian equity markets have corrected noticeably since their peak, seize the opportunity to invest some portion of your tax-saving investment portion in ELSS. But make sure you have an investment time horizon of at least 3 to 5 years and can bear calculated high risk.

Investing in the best ELSS, i.e. tax-saving mutual fund schemes, can prove to be a rewarding experience in the long run. The returns you earn from investments in ELSS can be utilised to meet your envisioned financial goals.

Happy Tax-Saving & Investing!

This article first appeared on PersonalFN here

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