ELSS: AN OPTION
BEYOND TAX SAVING

Can Equity Linked Savings
Schemes (ELSS) be looked from an investment alternative angle? As, off late,
the myth that Equity Linked Savings Schemes (ELSS) are useful only by providing
a tax benefit u/s 80C of IT Act, is fading away. In addition to being one of
the most invested tax saving instruments amongst Indians, the schemes are also
being seen as competitive mutual

Thanks
to the ease of investing and the continued patronage of fiscal policymakers,
today ELSS stand deviated from age-old LIC-for-tax-saving
mindset and in turn provide the business world with the household supply of
capital. Almost every fund house, excluding few newer ones, offers at least one
ELSS product as part of their product portfolio. There are schemes that have
been consistently delivering better returns than their own non-ELSS
counterparts. That does not mean, an individual can consider investing all his
ELSS allocation into one fund, nor does it also mean he can take smaller
exposures into a number of funds. Remember, too much diversification eats away
into the superlative performance of any individual fund.

Refer
the below table-1, a list of ELSS funds, top performing funds as on
12-Sept-16 (Source:
www.valueresearchonline.com) based on their 3 year return percentage.

It can be observed that the return generating capacity
is independent of the fund size or expense ratio or the age of the fund or the
analyst’s rating of the fund. Does the fund characteristic, irrespective
whether it was targeted to be so by the fund management team influence the fund
performance or it’s the result of the investment and stock picking process,
have any bearing on the performance of the ELSS schemes? A simple statistical
test was conducted to determine the same. A brief report with results is
presented in the next section.

We have studied the ELSS schemes of largest 15 (in
terms of AUM) AMCs, which gave us a sample of 19 funds. The objective was to
determine if certain fund characteristics, namely, the age of the fund,
portfolio turnover, size of the fund and the fund’s expense ratio, have any
bearing on the scheme’s performance (as measured by the 3 year CAGR generated).
The table-2
below provides a detailed summary of the funds studied.

We found that age of the fund, in contrast to the
popular belief, did not influence the fund performance at all. A fund like SBI Magnum
Tax Gain which is almost 24 years old, has delivered a 3-year return of 24.14%,
whereas the newest fund in the sample – Axis Long Term Equity Fund, which is
just about 7 years old has given a return of 30.80%. Conversely, we will be
wrong even if we conclude that newer the fund higher the return, as when funds
like IDFC Tax Advantage (ELSS) Fund that is 8 years old has given a return of
25%, compared to a much older fund like Birla Sun life Tax Relief ’96, which is
almost 20 years old, has given a return close to 29%. We just conclude that the
age of the fund cannot be a criterion in selecting a fund, given the criteria
of fund selection is return-generating capacity.

Portfolio turnover refers to the frequency of change in the portfolio
structure of the fund. In simple words, it signifies how frequently the fund
manager is buying and selling stocks within the fund. This is one criteria
generally used to by cost conscious investors, as higher turnover may be
leading to a higher expense ratio and thus affecting the NAV and also a higher
turnover is a symbol of active fund managing style over a passive style. The
debate is still on as to whether, in a market like India, an active management
can deliver superior return over a passive style. We found that portfolio
turnover do not impact the return generating capacity of the fund. Independent
of the turnover percentage, the funds have performed uniquely. An example could
be of ICICI Prudential Long Term Equity Fund whose turnover ratio is the
highest (at 152%) and that has given a return of 26.39%, compared with funds
like L&T Tax Saver and Birla Sun life Tax Plan, both of which had the
lowest portfolio turnover (close to just 3%) have delivered returns in the
range of 27-28%. Also, there is no homogeneity found among the funds in their
turnover ratio, considering all of them belong to a similar theme of funds. We
just conclude that portfolio turnover is not a criterion for investors in
deciding on the potential of an ELSS in generating returns.

Does the higher size of the fund imply a better
performance? Probably yes. At least as per our sample study. Axis Long Term
Equity Fund and Reliance Tax Saver Fund are the two largest ELSS among the
sample, which have given the highest returns also (31% and 34% respectively).
But, the proposition does not hold if we remove these two funds from the
sample. Funds with the lowest AUM like L & T Tax Saver Fund and Invesco
India Tax Plan have given above-average return (above 26%), compared to higher
sized funds like UTI Long Term Equity Fund, HDFC Long Term Advantage Fund and
Sundaram Tax Saver that have delivered a below-average return. We conclude that
fund size is a criterion that needs to be considered, but, it cannot be the
primary criterion in selecting fund. In the fund selection process, one may
have to use fund size tie breaker between two funds.

Another popularly used filtering criterion in
selecting mutual funds, especially in case of ELSS is the fund’s expense
ratio. Higher the expense ratio, it is assumed that fund management is
actively managing the fund and may be the stock picks are not going right. We tried
to see if higher expense ratio results in a varied performance in terms of
3-year return. Birla Sun life Tax Savings Fund had the highest expense ratio
and has delivered a below-average performance, whereas Axis Long Term Equity
Fund, which had the lowest expense ratio, delivered an above-average
performance. The trend could actually be observed throughout, and thus we
conclude based on the sample, that generally funds incurring high expenses tend
to deliver lower returns. Fund selection process may have to consider expense
ratio of the fund before selecting a fund.

To sum it up, ELSS need not be considered as mere tax
saving instruments. They can as well be part of the portfolio beyond this
reason. The size of the fund and the expense ratio are two criterions which may
have to be considered before investing in a fund. A larger fund with lower
expense ratio can any day be a better choice over the one their counterparts.