FUND FLAVOUR
November 2011

Goodbye ELSS!

We never did envisage the day when ELSS would become a thing of the past. From April 2012, this entire category of equity based tax saving schemes would be history. Frankly, this is a blow to investors. ELSS was the only tax saving instrument that combined tax saving with the higher return that is possible only through equity and the lowest lock-in period amongst all the other saving schemes. In fact, for many young investors, it was the gateway product through which they entered the stock market. It was after exploring this avenue that they began to get a taste for investing in diversified equity funds. Fund managers certainly were fond of these products. The 3-year lock in period ensured that investors could not walk out anytime and so sudden or frequent redemptions were not a prime concern. This enabled them to take a longer-term perspective on their portfolio.

Extinction of the generic ELSS?

ELSS Fund has become a generic term in the mutual fund industry. If we expand this term and say Equity Linked Savings Scheme Fund – it sounds odd. The assets under management of the 49 open and closed-end ELSS funds stand at Rs 24,571 crore. This is about 3.5% of the overall industry AUM and nearly 15% of the assets managed by all equity funds. ELSS products were introduced nearly two decades ago and initially there was a cap on investments allowed under this category, which was withdrawn around seven years ago. Investors are shifting from lump-sum investment to the systematic investment plan. The number of IFAs (independent financial advisors) selling mutual funds has come down significantly over the past year. This trend has hit inflows into ELSS in a big way. Lack of clarity on tax implications under the impending new DTC (Direct Tax Code) rules was the last straw on the camel’s back. ELSS Funds are on the death row. Their demise is slated for April 2012, when the Direct Tax Code comes into effect. This kept retail investors away from ELSS funds during the last fiscal, when inflows plunged 58%. Net inflows into equity-linked saving schemes, which provide tax benefits to investors, dropped to Rs. 606 crore last fiscal from 1,437 crore a year earlier. At the peak of the bull market in 2007, these funds raised assets worth 5,499 crore in the "tax-season months" between October 2007 and March 2008.

Promising performance

Over a 3 year time frame, most ELSS mutual funds have delivered competitive returns with Religare Tax Plan being the frontrunner (by delivering a return of 16.1% CAGR). Moreover, it has exposed its investors to fairly low risk (as revealed by its Standard Deviation of 7.72%), but has provided luring risk-adjusted returns (as revealed by the Sharpe Ratio of 0.15), thus making it a low risk-high return investment proposition in the category. Interestingly, the returns have been clocked by the fund without indulging in much portfolio churning (as revealed by its low portfolio churning of 0.66 times). Similarly, the other ELSS Funds such as Fidelity Tax Advantage Fund, Reliance Tax Saver Fund, Franklin India Taxshield Fund, HDFC TaxSaver Fund and DSPBR Tax Saver Fund too have delivered appealing returns over a 3-year time frame by managing their risk well (i.e. keeping it low) and thus providing luring risk-adjusted returns. As far as portfolio strategy is concerned, most ELSS funds hold a fairly diversified equity portfolio but predominantly of large caps. Moreover, most ELSS mutual funds generally follow a blend style of investing which enable them to follow both - growth as well as value investing. Speaking about the sectoral exposure, they generally occupy positions depending upon how the respective fund manager perceives each sector to be resilient and offers promising long-term growth prospects. However, as an approach to stock picking they follow the bottom-up approach, which help to identify promising investments.

Points to ponder
In the past, at present…

Invest in ELSS with a holistic perspective. First check your overall portfolio. Does it need more equity exposure? If yes, then you can go for ELSS; if no then you can go for PPF or NSC. Do not invest in ELSS except from tax saving point of view. Otherwise, it is better to invest in plain vanilla diversified equity funds. There are basically two reasons - liquidity and performance.

Spread your investment across 2 ELSS funds but not more. Choose growth over dividend and reinvestment option. Equity investments are for long term, say 5 years or more. Though the lock-in period in ELSS is 3 years, it is better to invest with a time horizon of 5 years or more.

You need to keep in mind that systematic investment plan is the best form of investing in mutual funds and ELSS is not an exception. So doing a SIP in ELSS is a good strategy to be followed.

You need to be careful in choosing the right ELSS scheme. Past performance, risk adjusted return, consistency over a minimum of three years are a few parameters to be evaluated in selecting a best performing ELSS scheme. Be wary of advertised returns.

…and in the future

Investments made before the date of commencement of DTC, in instruments which enjoy exempt-exempt-exempt (EEE) method of taxation under the current law, would continue to be eligible for EEE method of tax treatment for the full duration of the financial instrument. Individuals who want the tax benefit by investing in ELSS have only till March 31, 2012 to avail of it. Make hay while the sun shines. Which brings us to the next question, what will happen to ELSS Funds? Will all these tax saving schemes morph into plain vanilla equity diversified schemes? Once the tax saving benefit is pulled out, the lock-in period of 3 years makes absolutely no sense. We will have to wait and watch to see how funds deal with it.