How to select an ELSS

By Ravi Samalad |  29-01-21 | 
 
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About the Author
Ravi Samalad is Assistant Manager - Editoral for Morningstar.in.

Equity linked savings scheme (ELSS) is one of the less explored categories among investors when it comes to saving tax through the 80 C route, which is crowded with a host of other tax saving products.

ELSS has the shortest lock-in period of three years and the potential to generate superior returns in comparison to other traditional tax-saving avenues. Unit Linked Insurance Plan (ULIP), which also qualifies under section 80 C  is a close contender when it comes to performance since ULIPs also invest in equities. But ELSS schemes score over ULIPs in terms of costs and lock in period. ULIPs have a lock-in period of five years.

Almost all fund houses offer an ELSS scheme, which means there are 42 ELSS funds on offer. Thus, choosing the right fund to add to your cart can be tricky. Let us take a look at their investment strategy/style and the factors that investors should keep in mind while picking ELSS funds.

Benefits of ELSS

  • You have the ease of investing as little as Rs 500 per month or lumpsum. You can easily cancel or pause a systematic investment plan (SIP) in one fund and start in another. Do note that each instalment is locked in for three years.
  • Long term capital gains, held above one year, are taxed at 10% for gains exceeding Rs 1 lakh. An investor in the highest tax bracket could save Rs 46,800 tax for an investment of Rs 1.50 lakh in a fiscal year.
  • They come with three options – growth, dividend payout and dividend reinvestment. If you opt for dividend payout option, the dividends are tax-free in your hands. If you don’t need cash flows, it is wise to opt for growth plans as opting for dividend means a lower amount is getting compounded.

Performance

ELSS category has delivered 14.33% return over a one year period, as on January 28, 2021. The top performer has delivered 47.50% while the bottom performer has delivered 0.67% return over a one year period as on January 28, 2021. Thus, choosing the right fund is key. That said, chasing the best performer based on recent performance is a harmful strategy.

Here are some tips to analyse ELSS funds.

Investors should avoid making their investment decisions while looking at the past returns when it comes to any market-linked product. The same goes for ELSS. Let us evaluate a few funds that have done well and follow different investing styles.

Quant Tax Plan has topped the performance chart (1-year period) by delivering an eye-popping 46.27% return as on January 25, 2021. Over a 1-year period, the BSE Sensex has gained 17.60%, which means the fund has outperformed the index by 28.67 percentage points.

The fund adopts a concentrated investment strategy. As on December 2020, the fund held 29 stocks in the portfolio. Around 58.07% of the net assets of the fund were invested in top ten stocks. The portfolio is currently tilted towards healthcare (32.14%) and technology (17.73%), both sectors have done well during the pandemic era. The fund has a mix of exposure to small (8.58%) and micro caps (16.52%). This could expose investors to higher risk when the investment thesis plays against the fund manager.

Let us take a look at another fund, which has the largest assets (Rs 27,181 crore) in this category as on December 2020. Axis Long Term Equity Fund has delivered 17.62% return over a one-year period. This fund holds 32 stocks. The top ten stocks account for 65% of the portfolio. The fund has earned a Morningstar Analyst Rating of Bronze for its regular share class. This fund has a large cap tilt and the fund manager primarily invests in growth stocks.

Here is another ELSS fund which follows a contrasting strategy from Axis Long Term Equity.

HDFC Tax Saver Fund has one of the most diversified portfolios consisting of 63 stocks. It has a large cap tilt with a value blend. Roughly 70% to 80% is invested in large cap stocks and the remaining in mid caps. The fund has a minuscule exposure (1.96%) towards small caps as on December 2020. Even though both Axis Long Term Equity Fund and HDFC Tax Saver funds have a large cap tilt, the former invests in growth stocks while the latter has a value tilt.

(The fund names mentioned above are purely for illustrative purposes and not recommendations.)

Concentrated versus diversified

Some ELSS funds hold more than 60 stocks while others hold up to 30 stocks. A diversified portfolio could entail lower risk and lower return in comparison to funds that hold a more concentrated strategy. Both strategies (concentrated and diversified) have their pros and cons. So there is no one-size-fits-all fund.

Each fund is different

Even though all ELSS funds invest in equities they can be starkly different when you look under the hood. Each fund is unique depending on the sector or stock exposure, market capitalisation concentration and the style of the fund manager. Investors who are comfortable with higher volatility in ELSS could go for funds which have a small and mid cap tilt while those who wish to have stability in portfolio can go with funds that have typically a large cap bias.

It is a good idea to go for funds that have a long, consistent track record and are able to protect the downside in a bear market. The risk-reward payoff for different strategies will be different. Since ELSS is a market linked product the allocation to this category should be in sync with one’s risk appetite and financial goals. Also, one should take into account that the money is locked in for three years.

Performance of ELSS funds                    

Blank cells indicate that these funds have not completed three years.

(Investment Always Involves Risk of Loss)

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