It's that time of the year when the salaried invest in haste to save tax. Though financial planners call such lack of planning a cardinal investment sin, they are clear on one thing-that tax-saving mutual funds, called Equity-Linked Saving Schemes (ELSS), best serve the purpose by combining tax benefits with wealth creation using equities.
The main purpose of these schemes is tax saving. However, over the last few years, investors in these funds have grown their wealth tremendously. Funds such as Canara Robeco Tax Saver, Taurus Tax Shield and Franklin India Tax Shield Fund have delivered compounded annualised returns of 20-23 per cent in the last 10 years.
They have been among the top performers in the last five years within the category, have outperformed the Sensex and given returns in line with diversified large-cap funds.
In fact, over the last three years, they have beaten both large-cap funds and the Sensex.
Tax-saving funds follow the same strategy as diversified equity funds. "In fact, since tax-saving funds are diversified, they outperform sector funds in a down cycle," says Anil Rego, chief executive, Right Horizons, an investment firm.
Rego say the three-year lock-in works in favour of tax-saving funds, especially in the bear phase, as fund managers can take longer calls and deploy all the money as they don't have to fear premature redemptions.
The three-year lock-in period allows fund managers to take longer calls during a bear phase
Chief Executive, Right Horizons
Further, a large number of tax-saving funds have high exposure to mid- and small-cap stocks. "Because we have stability of corpus, we allocate a higher proportion of assets to mid- and small-cap companies," says Vetri Subramaniam, chief investment officer, Religare Mutual Fund.
Religare's tax-saving plan is among the aggressive ones with more than 40 per cent exposure to mid- and small-cap stocks. Subramaniam says the fund uses the lock-in period to take a long-term view. Despite high exposure to mid- and small-cap stocks, the fund has lost only 17 per cent in the last one year compared to a 24 per cent fall in the Sensex and 34 per cent in the mid-cap index.
"We prefer companies with healthy balance sheets and cash flows," says Subramanian. That has worked to the fund's advantage over the course of the year as due to rising inflation, interest rates and debt, the market has been kind to companies with healthy balance sheets and cash flows. Even during the crisis year of 2008, the fund's value fell 49 per cent compared to the category average return of -55 per cent and a 52 per cent fall in the Sensex.
"Although mid-cap and small-cap companies fall more during a downturn, they bounce back faster during upturns," says Soumendra Nath Lahiri, head of equities, Canara Robeco Asset Management.
Canara Robeco Tax Saver invests 70 per cent money in large-cap stocks and 20-30 per cent in mid- and small-cap stocks. It has been following a defensive strategy of being overweight on sectors such as pharmaceuticals and fast moving consumer goods and underweight on rate-sensitive sectors. This explains its 12 per cent return in the last five year, when the Sensex delivered -2 per cent and mid- and small-cap indices -3 per cent and -5 per cent, respectively. The fund's strategy of investing in companies that have less debt and good operating cash flows has worked for it.
Among the other top performers over the last five years are Taurus Tax Shield Fund, Fidelity Tax Advantage Fund and Franklin India Tax Shield Fund. Other funds with a history of more than 10 years, such as Magnum Tax Gain, HDFC Long Term Advantage Fund, HDFC Tax Saver Fund and ICICI Prudential Tax Plan, have returned above 25 per cent in the last 10 years.SHOULD YOU INVEST?
Rego says you should go for these funds only if your main aim is to save tax. Else, one should invest in diversified equity mutual funds for flexibility, as tax-saving funds do not allow you to book profit when the markets are rising due to the lock-in period.
Further, a lot has been written about the proposed Direct Taxes Code
(DTC), which is expected to do away with the tax benefit enjoyed by ELSS.
Having said that, the DTC Bill was not tabled in Parliament in this winter session and there is no clarity about when the code will come into effect.