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Index funds with ELSS benefit

"We believe that going forward, it will be increasingly difficult for equity funds to beat the broad based indices. Thus, we are offering a passive fund rather than an actively managed tax planner,'' says an official with the AMC.

It's an equity-linked savings scheme with a difference. Templeton Mutual Fund's "soon to be launched" tax planning fund will also be a passively managed index fund. The first of its kind in the ELSS circuit, Franklin India Index Tax Fund (FIITF) will track the 50-stock S&P CNX Nifty Index. Templeton already manages an open-end passive index fund, launched in July last year that also follows Nifty. However, the AMC has been forced to launch an identical product since plain equity funds cannot offers tax breaks under section 88 to investors. Thus, fund houses have to launch separate funds for this purpose. The kitty itself is not very large since investors can put a maximum of Rs 10,000 in ELSS from their annual investment limit of Rs 60,000 in tax saving instruments.

FIITF, like other ELS funds, will offer a diversified bundle of stocks but unlike its peers, it will not be actively managed. In other words, the fund will not attempt to beat the benchmark but merely mimic the returns from Nifty. This would be achieved by investing in the 50 stocks comprising the S&P CNX Nifty Index in approximately the same weight as in the index. To date, all ELS schemes have been diversified equity funds barring KP Taxshield '99 that invests at least 50% of its corpus in information technology stocks. This gives the fund a sectoral flavour.

With a three-year lock-in for these funds, fund managers have a high degree of maneuverability and they can take a larger bet on underrated stocks and turnaround stories in pursuit of returns. The lock-in ensures that there is no threat of redemption even in the face of a short-term underperformance. In fact, actively managed equity-linked saving funds have comprehensively beaten broad market indices over the three-year period. While the bunch of ELSS has given an average return of 44% for 3 years ended December 29, 2000, S&P CNX Total Return has delivered only 6.81%. The 30-stock BSE Sensex is worse at 2.77%. So, why is Templeton launching a passively managed ELSS when some of the actively managed tax planners have generated stupendous returns in the past?

"We believe that going forward, it will be increasingly difficult for equity funds to beat the broad based indices. Thus, we are offering a passive fund rather than an actively managed tax planner,'' said an official with the AMC. Whether this strategy from Templeton will be successful remains to be seen. "We would encourage investors to opt for systematic investment in the tax planner so that they can ride out the volatility in the indices,'' he added.

FIITF will offer a 20% tax rebate under section 88, which means that an investment of Rs 10,000 will reduce the annual tax liability by Rs 2,000. Besides the proposed launch of FIITF, HDFC Mutual Fund is currently in the market with its tax planner, which will be actively managed while IDBI Principal also shortly plans to launch its ELS scheme.