The Hindu Business Line : Tax saving funds: Attractive, but aggressive option

Planning to take the mutual fund route to tax planning? Then you probably shouldn't wait until the final months of the year to decide on your choices.

Selecting a good tax saving fund at the beginning of the financial year and using the systematic investment route to spread out your exposures in these funds over several months is the best course to follow. Tax saving funds being equity-oriented funds, and fairly aggressive at that, SIP investments may be the best way to ride out the volatility that is an inherent part of their returns.

Before deciding allocations to tax saving funds, investors should weigh the following pros and cons:

More aggressively managed: Unlike other equity funds that are specifically designated as large or mid cap-focused schemes, tax saving funds usually do not adhere to any stated market capitalisation focus.

Most funds in this category follow a flexicap approach to investing, altering allocations between large cap and mid-cap stocks on a dynamic basis.

Investors in such funds can thus reap the benefits of investing across the market capitalisation range.

But as most funds in this category do have a significant exposure to mid-cap stocks, the risk profile they carry is higher than that for plain vanilla diversified funds.

As these funds do shift their allocations significantly from year to year, periodic monitoring of fund returns/portfolio is called for.

Benefits of closed end fund: With each investor subject to a three-year lock-in period, tax saving funds offer the benefits of investing in a closed end fund, in that they usually have a relatively stable corpus.

This lets the fund manager take a relatively long-term view on his stock choices. However, as these funds have investors who have made investments at different entry points, the entire corpus is not locked in. Despite a stable corpus, there is greater pressure on the fund manager to perform than in the case of a closed end fund.

Small to mid-sized: As tax saving funds are the exclusive preserve of individual investors, the majority of these funds are small or mid-sized funds, though a few tax saving funds have grown to a Rs 1,000-crore-plus corpus. As of April 30, 2007, only Magnum Taxgain (Rs 1,900 crore), Reliance Taxsaver (Rs 1,600 crore) and UTI MEPUS (Rs 1,200 crore) managed an asset base of over Rs 1,000 crore in the tax saving space.

A smaller size (less than Rs 1,000 crore) usually leads to greater manoeuvrability of the portfolio (especially given the penchant for mid-cap stocks). But very small-sized funds (sub Rs 10 crore in assets) may not offer sufficient diversification and are best avoided.

The choices

If you are looking for tax saving funds for your portfolio, it is best to base your decision on the funds' five-year track record, given that this will capture performance across market cycles. The accompanying table lists a few funds that have a five-year track record of faring better. As with plain vanilla funds, tax saving funds too have faced greater difficulty in beating their benchmarks over the past one year.

Funds that have a reasonable five-year record and have also managed to beat the broad market (S&P 500 index) over the past one year are Principal Tax Saving Fund, Magnum Taxgain, Birla Equity Plan and Birla Sun Life Tax Relief. These would be reasonable choices for your portfolio.

Investors looking for low-risk investment options within the tax saving space would be better off with funds such as Birla Sun Life Tax Relief, Franklin Taxshield and HDFC Tax Saver; these funds allocate a relatively larger proportion of their portfolio (over 70 per cent) to large-cap stocks and thus may offer less volatile returns.

For aggressive investors, Birla Equity Plan (over 50 per cent allocation to mid-cap stocks) appears a good option.

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