Equity Linked Savings Schemes (ELSS) and New Fund Offer (NFO)

While there is no disputing the fact that tax saving schemes Equity Linked Savings Schemes (ELSS) are an excellent investment avenue, the choice between existing schemes and New Fund Offer (NFO) could be a difficult one for some investors. In this article we are giving below some highlights, the benefits and disadvantages of both.

Equity Linked Savings Schemes (ELSS), also called tax saving schemes, are a highly popular investment avenue since they offer investors benefits that go beyond those available in other diversified mutual funds. They come with a tax benefit under section 80C, which enables to claim a deduction of up to Rs 100,000 per annum, to the extent of the investment, in keeping with the stipulations of this section. Beyond that, the three year lock in period, which characterizes this product, encourages savings. However, most retail investors still seem to be at a loss when it comes to selecting between an existing ELSS plan and a New Fund Offer (NFO).

The experience of SR, a software professional, is a case in point. He had Rs 30,000 to invest in tax saving instruments under Section 80C, but was not sure which avenue to choose. He has already put Rs 40,000 into Public Provident Fund (PPF), and is now looking for a tax saving instrument that does not have such a long lock-in period and offers good returns, too. A financial advisor advised SR to invest the sum in an ELSS plan, elaborating on the benefits of such an investment. But even after that, SR was still not sure whether to invest in an existing scheme or an NFO.
If you think your plight is similar to that of SR, read on to find out the difference between existing ELSS plans and NFO, and the relative merits and demerits of each.

The most attractive feature of ELSS is that they help you invest in the stock markets through the mutual fund route and, at the same time, give you tax benefits under Section 80C. These schemes have a lock-in period of three years, which works to your advantage as the fund manager can make better long term investment decisions with no redemption pressures hanging over your head. Like most mutual fund schemes, ELSS comes in two varieties: open-ended and close-ended. In the case of open-ended ELSS, the fund house will continue to issue units no matter how many investors have already bought them, if the demand is high. Units of close-ended schemes are held only by investors who have purchased them at the time of the NFO, since the fund house does not sell units at the NAV to new investors.

At present, around 32 ELSS are available in the domestic market for individual investors. Of these, 7 were launched in fiscal year 2006-07 alone. Close to 18 schemes are more than five years old, while the rest have been in existence for only five years.
In the case of an existing scheme, the investor has access to the scheme’s performance record. This is a major factor that attracts investors towards existing ELSS. They are able to study the past performance of the scheme and benchmark returns of an existing scheme with those of others. In addition, various statistical tools such as standard deviation, the Sharpe ratio, etc. are available in the case of existing schemes. This enables investors to make an informed decision.

Further, in the case of such schemes, an investor can gauge whether the customer services the fund house offers are good or not. If these services are not satisfactory, investors tend to ignore offerings from such fund houses.
A lower expense ratio is another reason why investors are drawn to existing ELSS, as the fund doesn’t have to spend heavily on sales promotion or marketing.
Benefits of NFO:

Investors normally opt for an NFO from a fund house when they are already satisfied with the performance of other schemes from the same stable.

If you choose to invest in an NFO, remember to evaluate a few things like the performance record of other schemes launched by the fund house, its fund management team, the investor services it offers and whether the firm has a good standing when it comes to corporate governance.

Many investors harbor the notion that funds available at par value or near par value are cheaper. This is a misconception. Unlike shares, the NAV of a mutual fund is determined on the basis of the underlying investments held by the fund house. There is no scope for gains on listing or the scheme becoming open-ended, in the case of ELSS as in the case of shares. Hence, the value of the NAV is not of any great significance in deciding which scheme to invest in.

While each type of ELSS plan offers peculiar benefits, you, as an investor, should choose a scheme after evaluating its merits and demerits. It makes sense to deploy your surplus money in more than one ELSS scheme, as it will enable you to diversify market risks.