Stay with ELSS funds despite recent poor run

Mutual Funds | admin | November 4, 2011 at 5:05 am

Soon after the Diwali holidays, most organisations will start sending reminders to employees asking them to submit proof of their investments before December if they want to claim tax breaks.

Typically, a large number of individuals, who practise the last-minute run every year, would take stock of their savings and investment options before making an investment decision just before the end of the month.

However, the decision-making process may not be easy this time. What queers the pitch is the lacklustre performance of tax-planning mutual funds, the entry point for most individuals to the stock markets, in the past year.

Tax-planning mutual funds, or equity-linked saving schemes (ELSS), as a category have lost 13.87% over the past year, as on October 28, according to Value Research, an independent mutual fund tracking firm.

Now, that gives rise to a real dilemma for an average investor: should I opt for the traditional, assured-returns products offering around 8%, or can I still take a shot at ELSS, which is supposed to offer better returns in the long run?

ELSS versus other tax-saving Options

"ELSS and traditional schemes such as public provident fund ( PPF) are not strictly comparable with each other since the risk returns involved are different," points out Amar Pandit, chief executive officer, My Financial Advisor.

An ELSS, or tax-saving mutual fund scheme, is meant for investors with a high risk appetite looking for higher returns. For the uninitiated, ELSS is an open-ended mutual fund scheme that aims to generate long-term capital appreciation for investors by investing in equities and related instruments. You can start with as low as 500. Each investment will have a lock-in period of three years from the date of allotment of units.

Investments up to 1 lakh each financial year can bring in tax exemption for you.

On the other hand, the traditional, assured-returns schemes are meant for conservative investors who would settle for modest returns.

"Your preference in the tax-saving space should be governed by your returns expectations, ability to take risk, financial goals, asset allocation and the time frame you are looking to stay invested," says Pandit.

Is ELSS good avenue for investment?

Also, experts warn investors against looking at the short-term performance of ELSS.

"Do not look at the short-term performance of a few months or just one year when you are looking at ELSS, which is expected to deliver over a long period of time," says Vishal Dhawan, founder, Plan Ahead Wealth Advisors. For example, many of these schemes have more than 10 years of performance track record, which mean you can reasonably expect returns of around 15% in the long term from them (See Table).

And that, too, tax-free returns, as these schemes have a lock-in period of three years and you don't have to pay any tax on returns from equity investments held for more than a year.

As for the short-term performance of these schemes, the current lacklustre performance is in sync with the falling markets, and there is nothing wrong with ELSS as an investment product as such. "Equity markets are attractively priced for long-term investors and it is fair to expect 12-15% annualised returns over the next three years from Indian equities," says Kunj Bansal, chief investment officer, Sanlam India AMC.

In a growth market, investors need to own a well-diversified equity portfolio to participate in the upward rally. ELSS does just that. Most funds in the ELSS category take a multi-cap approach and invest in companies across sectors and market capitalisations. The lock-in period of three years helps the fund manager to take a long-term call across businesses, which ultimately benefits investors in ELSS.

ELSS can bring in twin benefits to investors – savings on tax payable and also participating in the India growth story to earn high returns in the long term.

"This may be the last year of the existence of ELSSs if the direct tax code is implemented in the beginning of the next financial year, and one should take this opportunity with both hands to own Indian equities by investing in them," says Dhruv Raj Chatterjee, senior research analyst, Morningstar India.

Like any other equity investment, it pays to be a long-term investor in ELSS. Many treat the three-year lock-in period of ELSS as a 'term' of the investment and lose out on the long-term wealth it can create for them.

There is no need to sell your investments in ELSS after you complete the three year lock-in period. You can hold on to your investments in ELSS like any other diversified equity fund. If you do not withdraw your money every third year, the money will compound over a longer period of time and will help you build a nest egg.

ELSS' ability to compound money in the long term is also visible in the increase in net asset value of some of the schemes. A case in point is HDFC Taxsaver Fund's growth option. The scheme was launched in March 1996 and has delivered 31% annualised returns since inception and its NAV stands at 216, a 20 times increase over approximately 15 years. Of course, not all schemes have done equally well.

It is better to invest after checking the long-term performance of the scheme and keep track of your investments in ELSS.

Source: Economic Times

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