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If you choose the old tax regime, it is ideal to start your tax planning investments at the beginning of the financial year. Equity Linked Savings Scheme (ELSS) is a popular avenue as investors can enjoy tax deduction on investment. The tax deduction is available under Section 80C of the Income Tax Act, 1961. There are over three dozen ELSS funds available in the market. Since these are tax-saving funds that come with a three-year lock-in, selecting the right scheme becomes very important as you cannot break the investment mid-way. Below are factors to keep in mind while going for your ideal ELSS.
Consistency in performance
Investment platforms and asset management companies display historical returns of funds. Usually, they are one and three-year, point to point returns. Some show category average returns too. A fund can do well in certain phases, but perform badly in other times. Did you know that the best ELSS of 2017 became the second-worst in 2018? So as an investor, what you actually want is consistency in performance.
Evaluate returns on a calendar year basis for a few years and select funds that figure in the top performers’ list consistently. Another way to assess consistent performance is by looking at rolling returns, which remove any bias towards periods under review, and are suitable for a SIP investor. Take several blocks of three-, five- or 10-year periods at various intervals. Do not look at fund returns standalone. Compare them with peer group and stated benchmark.
Downside containment
ELSS fund should have the ability to contain downsides well. Well-managed equity funds, including ELSS, should defend well in a correction phase. So, you must look at the downside protection element in funds. Here is how you can look at it. One, select calendar/financial years when markets didn't perform that well and look at how your shortlisted ELSS funds fared. In the last decade, 2011 and 2015 saw Nifty clocking negative returns, while percentage returns were in single-digits for 2013, 2016 and 2018. Study whether the shortlisted funds shielded vis-a-vis markets, peers and benchmark. Two, you can also look at downside capture ratios of ELSS funds from publicly-available resources. A downside capture ratio of less than 100 indicates that a fund has lost less than its benchmark in periods when the benchmark has been in the red.
Strategy, style
The investment strategy across market capitalisation (mcap) of portfolio stocks is an important thing to see in ELSS funds. Simply put, this decides how much of the fund money goes into large-cap stocks, mid-cap stocks and small-cap stocks.
Large-caps are the safest. The risk factor as well as return potential rises in mid-caps and small-caps. It can be useful to understand where your ELSS fund sits in the mcap distribution spectrum. The ELSS category has average 69 per cent exposure to large-caps, 19 per cent mid-caps, 8 per cent small-caps and 4 per cent others (cash). There are funds such as ABSL Tax Relief '96, IDFC Tax Advantage and Quant Tax Plan that have 50-52 per cent allocation to large-caps. Small-cap exposure should set higher return expectation for the higher risk assumed. For instance, funds such as Taurus Tax Shield, Tata India Tax Savings, Edelweiss Long Term Equity have double the category average allocation to small-caps. If their returns are in line with category, the higher risk is not being compensated.
Similarly, the investment style viz. value, growth or blend is important in an ELSS fund. Growth style of investing means fund managers are willing to pay high price-to-earnings multiples for growing firms and more volatile bets than broader market. Value investing characteristics include lower-priced PE than broader market and carry somewhat less risk than broader market. Managers of many ELSS funds articulate their style. If they don't, try to read media interviews or fund reviews of the particular ELSS funds. According to ACE MF data, the portfolio PE of ELSS category ranges from 25 times (Quantum Tax Saving) to 57 times (Axis Long Term Equity). There will be periods when markets shift from growth to value which also impacts returns.
Expense ratio
The cost of returns is expressed as total expense ratio (TER). The lower the TER, the better it is for the investor. But do remember as per norms, funds with bigger assets are mandated to charge lower TER. And, there is no surety that big funds would be better at performance than smaller funds. Still, TER is a factor for selecting ELSS funds. Higher TER pulls the NAV of a fund downwards, so it is better to strike a balance between fund returns and its expense ratio.
TER is only significant when the fund is being assessed for long-term investment. Total expenses eat away a chunk of the actual returns of the fund. Remember that higher expense ratio does not reflect the ELSS fund's ability to create superior returns. Therefore, a higher TER does not guarantee better performance. The TER range for tax-saving funds (regular plan) is 1.6-2.5 per cent, but if you buy direct plans, the costs can drop by up to 80 per cent.
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