How to select an ELSS

By Morningstar |  28-02-18 | 

Choosing a fund to invest in can be a bit overwhelming. Thanks to the tremendous choice available, sifting the wheat from the chaff calls for some amount of hard work.

No doubt, the number of funds in the Equity Linked Savings Scheme (ELSS) category are much less in comparison to the diversified equity category, it still requires effort to make the right choice.

4 things to note about ELSS

Here are some criteria to rely on.

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

Don’t fall blindly for chart toppers.

As with any fund investment, an error investors are prone to make is opting for the most recent chart topper. Despite the bold disclaimers about past performance not necessarily being sustained in the future, investors have a hard time resisting that lure.

When latest performance is employed as a sole parameter, it’s not uncommon for disillusionment to set in rapidly. That’s the best case scenario. The worst case being you will lose your money. Often when you dig deeper, the fund is not what it appears to be.

Take Principal Tax Savings. Its performance was outstanding in 2012. But a smart investor would have checked past performance to realise that it underperformed the category average over the prior four calendar years.

Or consider BOI AXA Tax Advantage Eco. The fund’s performance was exemplary in 2017 at almost 60%. But in the 7 years prior, it had underperformed the category average in 5 calendar years and delivered an average return in one.

When we looked at the 3-year performance of ELSS funds as on December 31, 2017 (regular & growth schemes), Escorts Tax Plan topped the chart with an annualized 3-year return of 19.42%. But over the past 10 calendar years, it underperformed the category average in seven.

Never view performance in isolation.

While one must not get swayed by a sporadic burst in numbers, performance should be viewed in conjunction with the fund’s investing mandate and style. In a mid-cap rally, a fund whose portfolio is packed with such stocks will naturally benefit. It does not mean that a fund not doing particularly well is a bad fund; it’s just that the latter may be a large-cap oriented fund.

No fund will always be a chart topper. But by and large, how does it perform? How has the fund held up on the downside? Does it fall hard in down markets but screams ahead during rallies? Or is there no rhyme nor reason behind when the fund does well and when it does not? Are its fortunes highly dependent on its top holdings?

For instance, investors in a fund like Reliance Tax Saver may not really look for consistency in returns because the fund has tremendous potential and over time rewards investors. The fund put up a great show in 2012, leaving the category average way behind. The very next year it slipped down and underperformed the category average only to again bounce back in 2014. The following two years were not great for the fund but again put up a good show in 2017.

On the other hand, don’t kick a fund to the curb just because of underperformance. It could be that the investment style is currently out of favour and not a reflection of bad fund management. For instance, Franklin India Taxshield underperformed the category average in 2012 and 2013, only to bounce back and reward investors. In 2016, the fund went through some fundamental changes in terms of change in the manager and investment strategy. It did underperform in 2017 but Morningstar’s analysts believe that the fund manager shows promise and are positive on the fund’s outlook.

Look under the hood to check what the fund is made up of.

All ELSS are diversified equity funds, meaning investments are across sectors (auto, banking, FMCG etc) and themes (infrastructure, financials etc).  All offer a tax break under Section 80C. That is the common denominator. But don't assume there is a lot of similarity between funds.

A look at various portfolios will reveal that some funds are much more concentrated in their top bets than others. The top 10 stock holdings of HDFC Long Term Advantage and Axis Long Term Equity corner a little over 50% of their corresponding portfolios. On the other hand, the corresponding figure for Baroda Pioneer ELSS 96 is around 35%.

Last year, Edelweiss ELSS had a very diversified portfolio of 72 stocks with the top 10 accounting for just 27% of the portfolio. It is now around 60 stocks with the top 10 garnering 37% of the portfolio.

Canara Robeco Equity Tax Saver has 72% of its portfolio in large caps. It has now inched up to 80%.

Quantum Tax Saving has a tight portfolio of around 24 stocks with the top 10 cornering more than 50%. High cash calls are also a mark of this fund when they find no value in the market. Around 86% of the stock portfolio is in large caps.

IDFC Tax Advantage has half the portfolio allocated to mid, small and micro caps with cash cornering a little over 3% of the portfolio.

The points being made here:

  • Don't go by the latest performance numbers. Look at how the funds have performed over the past years and in downturns too.
  • Don't assume that all the portfolios of tax-saving funds are more or less identical.
  • Select a fund which fits in with your overall portfolio and strategy and suits your temperament.
  • If you shun smaller fare, then avoid funds which have a mid- and small-cap orientation. Or maybe you would prefer a flexi-cap strategy. Decide whether you are more at ease with a very diversified portfolio or would prefer a focused and concentrated one. Or if a value strategy is more what you identify with rather than hard-core growth.

Do download the Complete ELSS Guide. It's Free. All you need to do is register.

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Vinamra Gharat
Mar 1 2018 05:09 PM
Yes this article shows how to choose a ELSS which is suitable to an investor. For example, I usually recommend IDFC Tax Advantage to young investors with very long term horizon (7+ years) and has some willingness to take extra volatility while Franklin Tax shield to middle aged or retired investors who cannot deal huge amount of volatility. Also the article discusses on fundamental factors such as change in manager. For example, Anoop Bhaskar left UTI for IDFC, so being a very good manager with a reputation to pick mid and small caps, Anoop is doing great at IDFC. I actually allocated more money to IDFC because of two great managers on both Equity and Debt side. Great article.
Himanshu Maheshwari
Feb 28 2018 08:44 PM
is there any consistency in fund management style over period of time.
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