Popularly referred to as ELSS/equity-linked saving schemes, tax saving mutual funds showed some really good performance in 2017, with its good run beginning in June 2016. The average returns of ELSS were very welcoming and the yields increased to an average of 26 percent during this fantastic performance period. Comparatively, the large caps category delivered 21 percent average returns while the BSE Sensex had average returns of 16 percent during this period. It is important to note that most of the funds that were bracketed under the tax-savings plan option offered returns of over 30 percent in the last one year.
It is however important to remember that the fabulous results offered by tax saving mutual funds is not an anomaly. It is a fact that these funds have performed better than their peers, time and again, for long periods of time, for as long as a decade. Tax-saving schemes have offered 20 percent returns over the past 5 years as opposed to the over 12.5 percent returns provided by the broader market during the same period. Thus, people who had put ion INR 1 lakh in tax savings funds during this period would have accumulated a corpus of nearly INR 2.50 lakhs. Investment of the same sum in the broader market would have offered a growth in corpus to around INR 1.85 lakhs.
What makes ELSS funds distinctive?
One of the major differences between the equity-based tax saving schemes and the diversified, regular equity-based mutual funds is that the equity-linked saving schemes come with tax deductions and also offer a chance of appreciation of invested capital. Tax-saving schemes are eligible for tax exemptions under Section 80C of the IT Act. Up to INR 1.5 lakhs of the investment in ELSS funds qualifies for tax deductions; thus, people who fall in the top tax slab will end up saving almost 30 percent (i.e., up to INR 45,000) on taxes on an ELSS investment of INR 1.5 lakhs, per year. It may however be noted that upper limit for investments in ELSS funds is not there. The tax rebate is not applicable to regular equity-based funds, but both the regular equity schemes and ELSS are eligible for nil LTCG/long term capital gains taxation. Dividends accrued from both kinds of MFs are also taxation free for all investors.
Similar to the normal equity-based mutual funds, ELSS like tax saving funds also put their monies into a portfolio made up of stocks of mid and large caps. Therefore investors in ELSS funds have to build their investment strategy around the portfolio make-up of the tax saving funds. However, unlike regular diversified equity MFs which allows investors to exit from the fund at any point in time after payment of mentioned exit loads, the tax-saving funds come with a lock-in period of 3 years. The lock-in period in ELSS funds is actually advantageous as the fund managers get the leeway of investing for a longer period without having to fret about possible liquidity. It may also be noted that investors who choose the SIP or systematic investment plan route for investing in tax saving funds, will not be able to withdraw it as each SIP investment also gets locked in for a period of 3 years.
Verification of the strategy and performance
Before investing in tax saving schemes like ELSS, investors need to verify their needs and priorities. They should ask of themselves different questions, including whether their financial goals are short-term and if they plan to sell the ELSS funds after the lock-in period is complete. It is important to remember that wealth creation needs investments for mid to long term periods. Hence, the right kind of fund which matches one’s financial goals needs to be found by the investors.
Strong belief and conviction
One can take the example of an ELSS mutual fund called the ‘Principal Tax Savings Fund.’ This scheme has been consistently offering its investors the best returns over the last 5 years. During this period, the fund delivered a return of 23 percent, while over the last 1 year the returns were a solid 36 percent. The fund managers at ‘Principal PNB Asset Management Company,’ the fund house that manages ‘Principal Tax Savings Fund,’ were successful in identifying bottom-up good stock prospects in varied sectors like cement, auto, financials, auto ancillaries, fertilizers, and aviations. They then held onto these stocks as they were confident of their performance.
The fund managers also allocated some beta stocks in the portfolio as well as increased the midcaps allocation in the portfolio. The combination of these two moves resulted in improved gains for the fund. Also, the fund had no significant investments in sectors like pharma and IT, which turned out to be really beneficial.
The returns of the fund were however cut back a bit due to its limited investments in metals in 2017. Despite this minor drawback, the performance of the fund remains superior as compared to its peers. The fund runs a mixed strategy that features exposure to mid caps as well as large caps. Many financial experts feel that tax saving MFs ought to have some kind of exposure to midcaps since the investment horizon of mid caps generally tends to be 3 years or more, which is similar to the nature of tax saving funds.
Financial focus for the long-term
Another good example of an ELSS mutual fund offering good returns is the ‘Axis Long Term Equity Fund.’ This fund has the distinctive strategy that involves identification and subsequent investments in varied stocks for a longer period that lasts anywhere between 3 and 5 years. This kind of investment strategy helps make sure that the fund puts its money in high-quality and sustainable stocks that come with the potential of consistent returns and growth. It also helps in looking beyond the short-term volatility in performance of the stocks and/or earnings till such time that long-term growth occurs.
Since the time the Axis Long Term Equity Fund was conceptualized, it has maintained a compact and stable portfolio and kept its focus on identification of similar great prospects across the wide spectrum of the markets. Like it happens with most equity based funds, 2016-17 was not a great year for the fund and it performed poorly, mostly due to better market performance of lower quality and beta stocks. Demonetization also had a bad impact on the fund as some of its major portfolio allocations in the consumer and financial industries had to bear the worst of the uncertainty in the markets. The fund has however recovered from that poor phase. It provided a return of 20 percent on investments over the last 1 year. This may not be good enough to beat the players at the top, but the main and basic point of steady growth imbibed in the core strategy of the fund continues to be maintained. With a solid return of 25 percent, the fund continues to be ranked amongst the best in the category of 5-year returns.
The position of Axis Long Term Equity Fund is most likely going to be associated with capture of future increase in domestic demand in the coming 2 to 3 years. As a result, most of the major portfolio allocations in the fund are on NBFCs/non-banking financial companies, private sector banks, and automobiles and other consumer durables. The fund has multi-cap investments with bottom-up portfolio allocations throughout the market, as and when and where different viable opportunities are identified. Over the past years, large cap allocation in the fund’s portfolio has typically been in the range of 60 to 70 percent.
New and successful tax saving ELSS fund in the market
The Mirae Asset Tax Saver Fund was launched around 18 months ago and thus is fairly new. However despite being the new kid on the block, the fund has beaten its peers by a big margin over the past 1 year. For the 1-year period beginning 20th June 2016, it has delivered returns of 38 percent, while the average performance of the category during the same period was only 26 percent.
The fund manager keeps a disciplined investment approach and has increased focus on diversification and quality. This is what has helped the fund deliver good returns on investment. A lot of decisions that were taken last year proved to be beneficial for the fund. For example, the fund had invested heavily in private finance companies like ICICI Bank, HDFC Bank, and Kotak Bank. The portfolio also had allocations to consumer discretionary sector like automobiles, etc. All these calls had a positive impact on the fund’s performance. Conversely, the fund’s investment in healthcare industry was not that fruitful. Even though the fund is sector and size non-compliant, over 60 percent of its portfolio weightage is for large caps. The main focus of the fund is investment in different growth businesses that present large-size prospects, but still can be purchased at affordable valuations.
It is postulated that over the next few years growth will be accelerated by financials, the economy’s consumption area, and varied other factors like decrease in the interest rates; the effect of the higher real wages due to revision by the Pay Commission; and the possibility of a good rainy season and its impact on the rural sector and economy. Some of the industries which are mostly likely to gain in the future are retail banking, consumer staples, auto durables, consumer goods, and building/construction materials.
Should you invest in tax saving funds?
Tax-saving funds are good for those individuals who want to receive a significant rebate on tax as well as grow their wealth by remaining invested in such funds for a longer duration. Investors need to calculate the amount that needs to be invested for getting maximum tax rebate. Even if saving on taxes is not the main motive, people can still opt for ELSS schemes for possible capital gains. As per different reports, nearly 90,000 new portfolios were added in May 2018 to the ELSS MF category. This indicates that tax planning is being taken seriously by investors and that they are not giving up on their ELSS investments after the tax season is over. It is also an indication of a gradual but steady shift from physical assets to financial assets.
The risk associated with equity is quite high and hence it is a better option to invest in a systematic manner, wherein you put away (invest) a small sum each month for a long time period instead of making a lump sum payment at one go. A monthly systematic investment plan will not just help people save money on a regular basis, but will also be helpful in riding through the volatility and fluctuations in the market. Keep a small chunk of your monthly salary on the side every month for investment in ELSS via SIP, and then happily watch your wealth buildup and grow!