With the tax season gaining momentum, Templeton India AMC has launched its first open-ended equity linked tax saving scheme. Christened Franklin India Index Tax Fund (FITF), its is a passive index fund which will track the S&P CNX Nifty. Investments up to Rs 10,000 would qualify for 20% tax rebate under section 88. The issue opens on February 26, 2001 and units will be offered at par. On subsequent reopening, units can be repurchased at NAV related prices on a no load basis till March 31, 2001. All investment will face a lock-in of 3 years.
What is an index fund?
A passive index fund tracks its chosen benchmark, which is S&P CNX Nifty for FITF. Thus, the fund would invest in the 50 scrips comprising the index, in approximately the same ratio as in the benchmark and not attempt to beat the benchmark. The advantages:
The index comprises of blue-chip liquid stocks, which are leaders in their respective industry. The S&P CNX Nifty today constitutes of scrips from as many as 25 diverse industry groups. With investments spread across a spectrum of industries and companies, an Index fund ensures a well-diversified portfolio.
Since it is a passively managed fund, the investment universe is pre-defined. Hence, annual expenses are minimal. FITF has set its annual recurring expenses at 2 %, which is lower than the 2.5% set by a diversified fund.
Index funds have relevance in some markets but not all. The evidence is that the more mature the market, the more difficult it is to add value from a managed portfolio. This is particularly pronounced as funds gain in size. On the other hand, Indian markets are gaining maturity and currently, beating the broad market is not a tough task.
The Tax angle
While most of the tax savings avenues are debt oriented, equity linked savings scheme is the only investment avenue which allows investors to reduce tax liability with an equity exposure. Investment of up to Rs 10,000 in any tax-planning fund gets a tax rebate of 20 per cent or Rs 2000 in a financial year. For instance, if your tax liability for financial year 2000-01 is Rs 15,000, it stands reduced to Rs 13,000 if you invest Rs 10,000 in an equity-linked tax planner.
Investment Details
The minimum investment in FITF is Rs 500. Further, if you plan to invest Rs 10000, you can make your task easier by adopting a systematic investment plan. By investing Rs 833 every month or Rs 2500 every quarter, the task of meeting an otherwise sizeable investment target is made simple. However, the total investment made in one financial year would be eligible for tax rebate in that financial year alone.
The Options
While FITF is a passively managed index fund, all other ELS schemes are actively managed. On the back of a relatively small corpus and three-year lock-in, these funds have comprehensively beaten the broad market indices, including Nifty. The VR category of 7 open-ended tax-planning schemes has posted an average return of 40.04% for the three years ended February 13, 2001. While funds like Zurich India Tax Saver have performed with a diversified portfolio, others like Alliance Capital Tax Relief '96 have delivered on the back of a technology oriented portfolio.
Over the same period, Nifty has given a poor return of 9.68%. If we look at the 3 year return track record of the index on a rolling basis since 1990, the best return of 61% from the index came in early 1994, while the worst performance of (-) 10% came in the bear markets of early 1997.
Conclusion
Sure, FITF with its blue-chip scrips is likely to be one of the most diversified portfolios. Also, coming from Templeton AMC, the service standards would be at par with the best in the industry. However, the issue is whether index funds is the right option in a tax-planning scheme, which typically have a small corpus and can be managed with a nimble footed strategy to generate superior returns. And on this count alone, odds shift heavily in favour of managed funds.
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