What is ELSS (Equity Linked Saving Scheme)?

ELSS, popularly known as Tax Saving Mutual Fund, is a category of Mutual Fund where a major portion is invested in Equity & Equity related instruments. Investment up to 1 lakh is exempted from income under section 80C but there is a lock in of 3 years before which you can not withdraw. However there is no upper limit on investments and long term capital appreciations are tax free. Dividends received are also tax free in the hands of the investor.

ELSS is a great instrument for tax planning which also ensures good returns. But investment should be carefully planned and you should devote sufficient time in selecting the right fund.

Types of ELSS

1. Growth: Investor does not get any income during the tenure of the investment. He will get a lump sum amount at the time of redemption or on maturity.

2. Dividend: Investor gets a dividend from the fund house. He has two options:

• He can cash on the dividends.
• He can opt for dividend re-investment option.

In most funds you have Growth as well as Dividend options which you can choose depending upon your priorities.

Best Funds

We present the top 7 funds based on last 5 years’ performance:

Figure 1. Source: Value Research

How to choose a fund for investing?

A good track record is no guarantee for future performance. You should also look at some quantitative measures to evaluate which fund is good for you.

Expense Ratio: Denotes the annual expenses of the funds, including the management fee, and administrative cost. Lower expense ratio is better

Sharpe Ratio: An indicator of whether an investment's return is due to smart investing decisions or a result of excess risk. Higher Sharpe Ratio is better

Alpha Ratio: Measures risk relative to the market or benchmark index. For investors, the more positive an alpha is, the better it is.

R-squared: Measures the percentage of an investment's movement that are attributable to movements in its benchmark index. A mutual fund should have a balance in R-square and ideally it should not be more than 90 and less than 80.

Figure 2. Source: Value Research

Which fund is best for you?

Choice depends upon your risk profile and priorities. You should take an investment decision based on overall financial planning.

Large Cap Funds: These funds mostly invest in the large cap companies. While this may mean muted returns when the markets are rising, it also may mean a limited downside when the going gets tough. Franklin India Tax shield and SBI Magnum Tax gain are a few examples of this type.

Growth Funds: These Funds have about 30% exposure to mid-caps, 10% to small-caps & the rest in large caps in its portfolio. Hence it may give a higher return in rising markets. Sundaram BNP Paribas Tax saver is a good option in this category.

Mid-cap Funds: No pain, no gain. These funds have a sizeable exposure to mid-caps and small-caps. This aggressive investment style can pay rich rewards. Sahara Tax Gain and HDFC Taxsaver are good examples of fund in this class.

Small Cap Funds: Small-cap stocks can act like performance enhancing drugs. In the above discussed types, the maximum allocation to small-caps is 12%. However, Taurus Tax shield has invested almost 30% in this high-risk zone. This can be very rewarding when the going is good, but a dream run can easily become a nightmare. Taurus Tax shield has given 98.01% returns in last 1 year.

Conclusion

You should do sufficient analysis before taking investment decisions. It should be guided by your overall financial situation, goals and risk profile. A Financial Plan is recommended before making investment decisions. SIP (Systematic Investment Plan) for a long time horizon is the most recommended way to invest in equity funds. You should avoid lump sum investment especially when the market is on a high.