ELSS funds

The last few years have been a bonanza for investors in equities and equity mutual funds in India. Investors have seen their money multiply several times over in the past few years, because of a multi-year bull run in Indian equities. One set of investors that has done particularly well is those who were smart enough to invest in the equity-linked savings schemes (ELSS) of mutual funds. These investors are fortunate not only have they got excellent returns, but they also have the benefits of tax savings thrown in, an unbeatable investment combination.

ELSS are special equity schemes launched by mutual funds that offer tax benefits for investment up to Rs 1 lakh under Section 80C of the income Tax Act, 1961. Investors must lock their money for three years in ELSS funds to take advantage of the tax benefits. In all other respects portfolio construction, sectoral allocation, scrip selection, and so on an ELSS is similar to a diversified equity find. So an ELSS is essentially a diversified equity fund in which you can invest up to Rs 1 lakh in any financial year, with a lock-in period of three years, to enjoy tax benefits.

ELSS compare well with other tax-saving instruments like National Savings Certificates (NSC) or the Public Provident Fund (PPF). Most tax saving instruments offer a fixed rate of return around 8% which is comparable to bank fixed deposits but they offer little in terms of growing capital, and they barely beat inflation, which has been hovering around 5%. ELSS on the other hand, offers the investor an advantage of capital growth over long term thus offering better returns.

The risk element in ELSS is much higher, because the risk of losing hard-earned capital if the market goes into a bear phase. It is difficult to envisage such a scenario in India over the next few years, so ELSS investors can look forward for high returns in the foreseeable future.

Another competitive advantage enjoyed by ELSS is the short lock-in period of only three years. By contrast, the lock-in for PPF is a whopping 15 years and for NSCs, six years. NSCs have additional disadvantages that returns on them are taxable. However, in case of ELSS, all capital gains are tax-free since the holding period of three years is any way higher than one year that is required for making capital gains tax-free. Again, ELSS funds regularly dole out tax free dividends.

A recent feature of ELSS funds is that most of them have been paying out high dividends. In some cases, almost a quarter or a third of the existing NAV is paid out as dividend to investors every year. This is a bonanza for investors who see a lot of money coming back their way through high dividends, effectively reducing their holding periods in ELSS funds. This makes ELSS funds even more attractive.

ELSS schemes have been around for over a decade now. The first one was launched way back in 1993. Today, investors have more than 35 ELSS schemes to choose from. The total corpus of ELSS schemes is a very respectable Rs 15,000 crore. That is more than 8% of the total equity assets managed by mutual funds in India. Remarkably, while assets under ELSS schemes stagnated at around Rs 450 crore up to March 2004, they have multiplied over 33 times in the last three years, reflecting the bullish trend and heightened investor interest in equities.

It is quite difficult to identify a few good ELSS schemes based on long term performance, as several funds have performed exceedingly well. Some notable schemes with an outstanding long term track record are Franklin India Tax shield Fund, Fidelity Tax Advantage Fund, HDFC Tax saver Fund, Sundaram BNP Paribas Tax saver Fund, and UTI Equity Tax Saving Plan.

Although ELSS funds are often-ended and can be bought at any time of the year, many investors make the mistake of investing in them only in the January to March quarter every year. Historically, most global markets are on a new high at that time, as new money is allocated in January each year by investors for various markets, and the new fund flows tend to cause markets to rally. ELSS investors can get more for their money if they invest during dips through the year, instead of waiting until the last quarter. A good alternative is to invest through a Systematic investment Plan (SIP) every month, which would lower the purchases price through averaging. In any case, investing in ELSS funds is a good idea for all investors, especially the salaried class, to avail of the high returns on equity, a low lock-in period, tax benefits under Section 80C, tax-free dividends and long term capital gains.