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Don’t let the tax bite

The market meltdown that battered the Equity-Linked Savings Scheme funds is now promising to make them winners. Here’s why you should consider investing in them this time.

twitter-logoManu Kaushik | Print Edition: March 22, 2009

If you are looking for taxsaving investment options, chances are that you’re thinking of giving the Equity-Linked Savings Scheme (ELSS) funds a miss this time, thanks to their abysmal performance over the past year. But market analysts reckon that would be a grave mistake. The market meltdown that battered the ELSS funds is now promising to make them winners. Here’s why you should consider investing in them this time.

The most compelling reason for investing in ELSS—offered by mutual funds—at this point of time is the lower net asset values (NAVs) at which these funds are available. With the Indian economy poised to do well over the long term, equity markets are expected to provide attractive returns over the next 2-3 years. Says Sukumar Rajah, Chief Investment Officer, Franklin Templeton: “The performance of equity funds over the past year has been quite dismal as the stock market has corrected sharply. A majority of funds has seen their NAVs drop by more than 50 per cent.

The sharp declines have resulted in attractive valuations from historical levels. Given the expected economic growth over the medium to long term, investors with a slightly higher risk profile should consider investing in equities, including ELSS products.” The ELSS funds, which invest primarily in equity and equityrelated securities, have other advantages over traditional tax saving instruments. For one, ELSS has the lowest lock-in period of three years. Second, the profits on the sale of ELSS units are currently treated as long-term capital gains and are not subject to tax. Third, there is no dividend distribution tax on equity investments and dividends thus earned are tax-free. And to top it all, ELSS funds offer investors the “power” of equities and thus the promise of higher rate of returns. Says Jayesh Shroff, Fund Manager, SBI Mutual Fund: “Compared to traditional tax-saving instruments that are purely debtoriented,

SBI magnum tax gain
SBI magnum tax gain
ELSS can help deliver better inflation-adjusted returns.” Besides, some fund houses are now bundling free insurance policy with their offerings. For example, Birla Sun Life Tax Relief and HSBC Tax Saver Equity are offering free critical illness cover, while DWS Tax Saving is giving free life insurance. The Reliance Tax Saver scheme comes with a free life insurance cover. ELSS funds come with two options— growth and dividend. While the latter option provides regular cash flow that is tax-free, in the growth option the dividend is added to the original investment in the form of units. Says Rajan Krishnan, CEO, Baroda Pioneer AMC: “As of today, the growth option looks more promising. Investors should go for an option that maximises returns rather than allows them to derive psychological comfort in the form of dividends payouts at regular intervals.”

For retail investors, the best way to enter ELSS now is through the systematic investment plan (SIP) route. This is because the market is quite volatile. In SIP, you gain when the market goes up and get more units if it comes down. So, it’s a win-win in both the scenarios.

There are around 36 ELSS funds in the market. Based on certain key parameters such as rate of return, experience of the fund house, stability of the investment team, consistent performance across market cycles and transparency and service levels, Business Today has zeroed in on the best three funds that can be added to the portfolio.

Sundaram BNP paribas tax saver
Sundaram BNP paribas tax saver
SBI magnum tax gain
It is one of the oldest and the largest tax-saving fund in the country with net assets of around Rs 2,400 crore. The fund’s 5-year annualised returns are the highest at 26.07 per cent as against 12.17 per cent for the entire category and 10.21 per cent for the Sensex. At present, the fund has invested over 70 per cent in equity and equity-related securities—including close to 69 per cent in large-cap blue-chip companies—and the rest in debt and other instruments. Since its launch in 1993, the fund has declared 10 dividends—the last one being a 110 per cent dividend in February 2008.

HDFC tax saver
HDFC tax saver
Sundaram BNP paribas tax saver
The fund’s 5-year annualised returns of 23.23 per cent are better than those of its peers, placing it at #2 among the tax-saving funds. Currently, large-cap stocks form 67 per cent of the fund’s portfolio followed by mid-caps at around 30 per cent. The fund’s top five holdings hover around 23 per cent of the total portfolio. The fund has been highly skewed towards sectors such as financial services, energy and FMCG, with the top three sectors constituting about 52 per cent of the fund’s net assets. With assets under management (AUM) of Rs 505.80 crore, the fund has invested over 85 per cent of the corpus in equities and the rest in cash and equivalent.

HDFC tax saver
Launched in December 1995, HDFC Tax Saver Fund has performed handsomely over the longer term horizon, posting annualised returns of 19.23 per cent over the last five years. The fund has strong leanings towards mid-cap stocks (44 per cent of the total portfolio), particularly in sectors such as banking and engineering. Over the past few months, it has stepped up its exposure to software stocks such as Infosys Technologies and TCS. At current valuations, its NAV is down by over 47 per cent compared to last year, but at the same time it has outperformed a vast number of its category peers. A positive aspect of the fund is its equity exposure which is as high as 95 per cent of the AUM. Whenever the market turnaround happens, the fund is going to deliver excellent returns.

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