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After the lock-in period, do not rush out of ELSS

A tax-saving mutual fund is just another fund with a 3-year lock-in. And analysis shows that staying invested in it beyond the lock-in is a good investment choice

Equity linked savings schemes (ELSS) are categorised as one of the investment options you have to include in your deductions under section 80C of the Indian Income-tax Act. Deductions under this section are fully exempt from tax up to an upper limit of Rs 1.5 lakh a year. ELSS shares space with other financial allocations in this section, such as your Employees' Provident Fund contribution, Public Provident Fund investment (PPF), and your life insurance premium.

An ELSS however is more than just a tax-saving investment. It is an equity mutual fund that is structured like any other, with the objective to generate consistent long-term returns by investing a majority of its corpus in equity shares.

Here are the three things you must keep in mind to maximise the efficiency of your ELSS investment.

The ELSS advantage
The major difference between an ELSS scheme and other equity-oriented funds is the statutory 3-year lock-in for the former and its tax-deductible status. Other than that, an ELSS is like any other equity fund. Think of it as a basket of stocks that the fund manager shuffles around every few months or years, to generate returns that match or outperform its benchmark. In most cases, these funds invest across market capitalisation, with a bias to large-cap. There are only a handful of ELSS funds that have a high allocation to midcap stocks. An analysis of returns over the last 5 or 10 years shows that these schemes are better than pure large-cap funds on a risk-adjusted return basis. What it means is that they can deliver a higher return with relatively lower volatility compared to large-cap funds. Performance is similar when compared to multi-cap funds (see graphic: 'Going beyond tax-saving').

What this means is that there is a long-term advantage in investing in ELSS funds over and above the tax advantage you received when you first invested your money.

According to Harsha Upadhyaya, head-equity, Kotak Asset Management Co. Ltd, "This scheme is similar to any other open-ended diversified equity fund and we don't distinguish it from others when it comes to stock-selection strategy. Even under the new categorisation guidelines, ELSS will have the flexibility to invest across market capitalisation."

Under the new categorisation guidelines, ELSS remains the same; there is no specification of market capitalisation within the equity basket. The minimum equity allocation is now 80%, which used to be 65% for equity-oriented schemes. There are investors who choose to remain with the fund even after the 3-year lock-in period is over. There are also others who invest in ELSS over and above the amount required for claiming the tax deduction.

An equity diversified fund
If you consider the category that has around 43 funds, at least 6 of them have asset under management (AUM) of more than Rs 5,000 crore. Large AUMs are uncommon in this category, which mostly has retail investors as patrons and that too for the limited purpose of fulfilling the investment required under section 80C. The upper limit under this section is Rs 1.5 lakh a year and this is shared with other financial allocations mentioned earlier. However, the largest fund in the category has assets under management of around Rs 16,500 crore. This shows that there are investors who invest in select ELSS schemes beyond the limit specified for tax deduction.

Jinesh Gopani, head - equity, Axis Asset Management Co. Ltd says, "Normally people don't leave just because the 3-year period is over. If you are happy with the return, then one doesn't change unless there is a market crash or a need for money; 20-30% exits do happen when the lock-in gets over but that too not in one go. Maintaining top-quartile performance helps us retain investors." For Axis Asset Management, there was a conscious effort for mobilising longterm money in the product more as a wealth-creation option than just for tax saving. Going by the AUM and performance, it seems that so far the strategy has been successful.

What to watch out for
Not all advisers are keen on allocating more funds than required to this type of fund, given that the lock-in provision does create a certain amount of inflexibility. According to Amol Joshi, founder, PlanRupee Investment Services, "The lock-in means that you will not be able to change your fund and that the overall asset allocation of the portfolio gets locked-in...for that time period. Rebalancing, even during significant market events, is not possible." If you have a systematic investment plan (SIP) running in an ELSS, keep in mind that every instalment has a lock-in and you will be able to access the money at different points in time as and when each SIP payment completes the 3-year period.

According to Suresh Sadagopan, founder, Ladder7 Financial Advisories, a Mumbai-based financial planning firm, "Selection of an ELSS fund is similar to any other equity fund. We have to consider return factors and other qualitative factors. However, there is a risk in locked-in funds if they don't perform well over the 3-year period; as an investor, you don't have recourse to switch." Within the section 80C deductions, ELSS schemes are perhaps the most efficient long-term option. For conservative investors, PPF does hold an appeal. However, given that their long-term risk-adjusted returns have been higher, one should actively consider allocating regularly to ELSS funds. You may even choose to invest large amounts, above your tax deduction limit, but be mindful that your investment will not be accessible, and to that extent unchangeable, for the first 3 years of lock-in. Also keep in mind, allocation to equity is most efficient over a period of more than 7-10 years.

In arrangement with HT Syndication | MINT