Historically, the period from October to March sees great investor interest in equity-linked saving schemes (ELSS). As the first half of the financial year ends, investors realise that they do not have much time left for tax planning. Hence, tax-saving funds crop up on their investment radar.
So it’s surprising to observe that the recent past has seen a change in that trend. The amount of money that investors put into tax-saving funds during October 2010 to January 2011 was meagre. This year, it was better but nowhere close to the gusto with which they considered these funds in 2008.
The lack of enthusiasm is not hard to decode. The volatile and lacklustre performance of the equity market has certainly dented the enthusiasm. To add to it is the uncertainty about the tax benefit under the Direct Tax Code (DTC). We never did envisage the day when the tax saving schemes of mutual funds would become a thing of the past. According to the earlier deadline, after March 31, 2012, this entire category of equity based tax saving schemes would be history.
That has been postponed again. But whenever it does happen, it will be a blow to the investor. These schemes are the only tax-saving instruments that combine tax saving with the higher return that is possible only through equity and the lowest lock-in period amongst all the other schemes. In fact, for many young investors, they were the gateway product through which they entered the stock market. It was after exploring this avenue that they began to get a taste for investing in diversified equity funds.
Fund managers certainly were fond of these products. The three-year lock in period ensured that investors could not walk out anytime and so sudden or frequent redemptions were not a prime concern here. This enabled them to take a longer-term perspective on their portfolio.
Of all the routes available under Section 80C, the New Pension Scheme (NPS) is the only one that offers some sort of equity exposure -- a maximum 50 per cent of an individual’s NPS corpus can be invested in equities. Unlike the three-year lock-in period of an ELSS, withdrawal from NPS can take place only at the time of retirement.
Imagine the plight of an affluent retired individual who currently relies on ELSS for tax savings. Once DTC comes into force, what tax-saving options would he be left with? A Public Provident Fund (PPF) account? Not a wise option since it matures after 15 years and offers limited liquidity after five years. NPS? Not possible since it is only open to individuals between 18 and 55 years of age, and certainly not retired individuals. Term insurance? What is the point since it is only beneficial to your beneficiaries when you pass away. This senior citizen will have no viable option available but to pay his tax.
According to the revised discussion paper (June 2010), “Investments made before the date of commencement of DTC in instruments which enjoy exempt-exempt-exempt (EEE) method of taxation under the current law would continue to be eligible for EEE method of tax treatment for the full duration of the financial instrument.” In other words, no matter when this category is discontinued, if you invest in it now, you will enjoy the break.
There are quite a few dissidents of this tax saving avenue. Specially those who invested at the peak of the bull run. The last six months of FY2007-08 witnessed a mobilisation of Rs 5,046 crore into tax-saving funds. The amount was the highest ever during this period. At that time, the market was at its peak and majority of the funds delivered dismal returns and most were in negative territory even after the completion of the lock-in period. That is why we always recommend a systematic investment even in such funds.
We looked at three funds: an above average fund, an average fund and a below average fund. The graph shows three-year annualized returns delivered by these funds you invested in over the past five years.
We can clearly see that even a below-average fund (LIC Nomura MF Tax Plan) has the potential to deliver a 35 per cent annualized return. Of course, the downside risk is higher but if we look at the percentage of occasions on which the fund has delivered a negative return, it is 24 per cent in the past five years. That means in 76 per cent of the time, the fund has delivered a positive return over the past five years.
And for an above average fund, this percentage is much higher at around 99 per cent. What this means is that over the past five-years, only in one per cent of the instances has the fund has delivered negative returns for a three-year period.
Here we recommend the eight best funds in the ‘Equity: Tax-saving’ category. Canara Robeco Equity Tax Saver, DSPBR Tax Saver, Fidelity Tax Advantage, Franklin India Taxshield, HDFC Taxsaver, ICICI Prudential Tax Plan, Religare Tax Plan, Taurus Tax Shield.
In a nutshell
* Unlike most equity fund categories that receive a steady flow of investments, tax planning funds receive disproportionately high inflows in the second half of the financial year.
* From all the schemes that fall under Section 80C, the only one with a 100 per cent equity exposure is the ELSS.
* The ELSS is the only tax-saving instrument with the shortest lock-in period of three years.
* If one takes a look at the returns, the ELSS is the most lucrative investment under Section 80C.
* The three-year lock in period ensures that investors cannot not walk out anytime and so sudden or frequent redemptions are not a prime concern here. This enables fund managers to take a longer-term perspective on their portfolio.
* Majority of the funds follow a multi-cap approach. In January 2007, the average large-cap allocation of these funds was 42 per cent. In December 2012, the figure stood at around 67 per cent. Barring a few like Franklin India Tax Shield, rarely has any tax-saving fund maintained a consistent large-cap bias.
* Escorts Tax Plan has around 70 per cent of its portfolio allocated to small caps.
* JP Morgan India Tax Advantage is the highest market capitalised fund with an average market capitalisation of around Rs 1 lakh crore. Interestingly, it also has the smallest number of stocks (16) in the category.
* DSP BlackRock Tax Saver holds the highest number of stocks (83).
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