The Mutual Fund Show: How ELSS Can Sweeten Your Tax Savings

A pretty popular category that lot of new first-time investors are following is ELSS, according to analysts.

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It is that time of the year when employers are asking for the proof of tax-saving investments that you were supposed to have made through the year. And according to analysts, first-time investors consider equity linked savings scheme of ELSS.

"ELSS fund run like any other diversified equity mutual fund, that's the one thing that just comes with an additional sweetener of your tax savings, at the time of investing," Kaustubh Belapurkar, director-fund research at Morningstar India, told BQ Prime's Alex Mathew.

"ELSS with a basic 12% assumption can give us a corpus of 4.05 crore, even after tax going by the current taxation it becomes a better option as compared to the others," Prableen Bajpai, founder of FinFix Research and Analytics, said.

Tax saving has to be part of your overall financial planning and requires a decent amount of deliberation, Bajpai said. "...If I have to put my own money and I know that I have to put it for the next 25-30 years, and I have the option of just going and buying the index, I'll do that, because it saves me a lot of hassle."

While ELSS comes with a three year lock-in period, investors should hold on to these for longer period of time, Belapurkar. "ELSS is like any other mutual fund, there is no need to redeem after the three year locking period is over, and when you look at the rolling returns of these funds they have been well in excess of 12-13% over long periods of time."

Watch the full video here:

Edited excerpts from the interview:

Prableen, I will start with you, because I think the foremost question everybody's going to have right now, both those who just entered the workforce and those who made these investments before is how does the ELSS stack up against the various other options that are currently available?

Prableen Bajpai: So, I think there are four, five popular investment options in India when it comes to Tax Saving. I think the number one thing the Public Provident Fund and followed by the Employee Provident Fund and these two belong to the fixed income basket that we have, because we know that this is the rate of return that we are going to get, seven point one and eight point one % currently on both of these. Then of course, we have a lot of these investment and insurance linked options, which is really not a great idea, especially when we are looking at long-term investments. So, I leave that out, but of course, they are available. Then, of course, is the NPS which gives us, you know, different combinations of Corporate Bonds of Government Securities and Equity. But again, there is a limited % percentage to which equity investments are available, going up to a maximum of 75%. Then we have of course, the Tax Savers, the Mutual Funds and of course, the fixed income, the first two products, the PPF and EPF are we know that we have a guaranteed return on them. We have tax exemptions even at the time of maturity of the product, but these two are not growth assets. These two are fixed income products and what we have in the growth asset basket is partially NPS and Mutual funds. In terms of return matrix, if we look at somebody who's starting off with their careers today or has been investing, you know, looking at tax saving options as a long-term investment option.

Let's consider a time period of let’s say for 30 years, if you started around 25 and are investing till 55 to your retirement or PPF at seven point one % can actually build up a corpus of one point five crores, EPS at eight point one. I am taking an eight can build up a corpus of one point eight three crores, of course, higher.

NPS, I am taking it at 10% because it's a combination of these different assets. It can create about two point seven one and with NPS we also have the additional 50,000 which can be made, so it makes it about two lakhs in a financial year. So, it can take us to about three point six one crores, but ELSS with a basic 12% assumption can give us a corpus of four point zero five crores, even after tax going by the current taxation it becomes a better option as compared to the others.

But of course, the choice of product depends on what is your you know, mandatory sort of deduction if you already have EPF through your employer. What is your overall investment bucket, you know, during the month, and of course, you know, what's your risk appetite, what are your goals. So, I think cumulatively all of it should be considered while picking the product.

That's a very nice summation of the options available, clearly a lot of salaried employees, like you said will already have contributions to the Employee Provident fund, and so the natural mathematical calculation that you will have to do is to calculate how much your contributions are, deduct that from one point five lakhs and then decide where you are going to invest but assume that we are talking about ELSS right now. Kaustubh, question to you. How are these funds managed and we spoke about the return potential of these funds and Prableen had a 12% number. Is that something that is consistently achievable over a long period of time?

Kaustubh Belapurkar: I think Prableen really laid the context well, in terms of, you know, the options that are available to investors when it comes to tax saving, when you think about the ADC Tax Saver. Now, a couple of things that you think about an ELSS fund. Essentially, it’s run like any other diversified equity mutual fund.  

I mean, that's the one thing that just comes with an additional sweetener of your tax savings, at the time of investing. When you look at the way large part of the ELSS funds, as you rightly said, it's a pretty popular category, a lot of new first-time investors are also kind of involving into the markets through ELSS.

So, a lot of managers tend to focus on building what we would call a larger cap biased portfolio. So as data shows us that you know, they do have a large cap bias anywhere between 65 to 75% of the assets for most funds goes into large cap stocks and the remaining between mid and small cap. So, it's a Flexi cap sort of mandate, but with a clear large cap bias that comes in for you when you see most ELSS funds the way they are managed.  

I think the important thing that Prableen did touch upon is the return expectations. What we have seen is over long periods of time, if you have the right time horizon, typically five years or more. Remember these come with the three year lock in but nothing stops you and in fact you should hold on to your ELSS investments for longer time periods because it's like any other mutual fund, there is no need to redeem after that three year locking period is over and when you look at the rolling returns of these funds they have been well in excess of 12-13% over long periods of time.

So, I think obviously it's a function of the way the markets do, but if you are consistently investing in these funds, you can definitely enjoy the returns of what a typical diversified equity Flexi Cap or  ELSS fund would kind of give you and that's what we have seen with good ELSS funds that are managed and mind you, there are a lot of  marquee managers who are managing the ELSS funds within that space. 

So again, interesting insights that 12-13 % is something that you can definitely expect to achieve over a longer period of time. But Prableen, I am coming back to you one, the mode of investment which is how do you deploy funds into the ELSS. Like I said at the start of the conversation, most people end up thinking about tax saving investments when they get that email or when they get that prod to say okay, we need your proof and so then it has to be a lump sum investment. But as it is a mutual fund, the option is available to invest throughout the year, should you consider SIPs and how do you treat ELSS as part of your overall portfolio, again people tend to think of tax saving investments outside of their regular investments and it should like you said form part of a goal that you have. So how should you treat that? 

Prableen Bajpai: Okay, so I will answer the second part first. Tax Saving and the whole planning process has to be part of your overall financial planning and so it means a decent amount of deliberation. You shouldn't just go and park in whatever you think is right or look for the best performing fund in the month of February or March.

Now, as far as the timing of investment in the mode of investment is concerned. So, I did some maths and I am just taking Franklin Tax Shield as an example. Somebody let's say, started with your SIP in this fund in January of 2013 and invested till December of 2022. So that is 10 years, and let's consider the calendar year as our financial year for now for ease. So, the person would earn about an investment of 50 lakhs during this time period. The returns today would be about 32 lakhs, which is quite good and if in case a lump sum investment was done, so now we have two options, when you start in January of 2013 or are you actually doing it to December of 2013.

So, let's consider that because it's a last-minute investment a person invested in December. That investment today would be around 29 lakhs. So, it's not a very huge difference but there is a difference of about three lakhs and of course this difference can be the other way round also depending on how the markets are. But I think what is important here is the consistency that you are doing this drill year on year, you are not chasing the best performing fund; you are investing in the same fund in a planned and consistent manner.

I think if you are doing that, then over a longer period of time, I think SIP, or a lump sum won't make much of a difference. I think the difference that we will get will also depend on the market conditions. But I think that consistency is the key here. I think the other thing what happens is a lot of salaried people prefer the SIP mode and when we interact with investors, a lot of entrepreneurs actually don't want to commit to a monthly sort of, you know, investment commitment. They don't want to do that. So, they prefer a lump sum.

So, I think the mode is not important till the time you have clarity that this is what I am going to do and this is the month when I am going to address, I think results should be almost similar. So, the process becomes more important here.

So, what I am taking from that is it also depends on your cash flow and for a lot of people I think that starts out in that availability of cash flow becomes a bit of an issue towards the end of the year. You can't necessarily pull out a lakh of rupees or maybe 80,000 rupees depending on how much you are contributing to the Provident fund to suddenly make your tax saving investments at the end of the year. So perhaps, for those people, it's a better idea to invest through the year, you know, in the recent past just over the last six months or so. There's also this conversation about passive ELSS and you have one fund that has come out.  What is your thinking about this Kaustubh, in terms of the opportunity that this presents and also I must point out that there was a recent clarification by the SEBI, where they said that if you currently have an active ELSS and from the perspective of the asset management company, they can pause or stop flows into that active fund and then simultaneously launch a passive fund and eventually merge the two. So what are the opportunities and how should a retail investor look at a passive ELSS option?

 Kaustubh Belapurkar: So I think, firstly, it's an interesting option and I think that debate is very much in play, you know, the active versus passive debate. We definitely think there's space for both. So, it's not one versus the other and it truly depends on what the investors are looking for.

The first prerogative  of the investor obviously, you know, what they think about the fitment of that sort of asset class and if it is an equity asset class,  in his or her portfolio, and if that's there, you know, the next choices you know, which fund do I pick and sometimes it becomes challenging for an investor who's probably, you know, kind of grappling with that, okay, there's so many funds, how do I go about making that choice is what we call choice paralysis, and that's where a passive fund could possibly  ELSS fund could work wonders, where, you know, instead of sitting on the sidelines and wondering, well, I can't pick between these funds and making no choice.

Here you just come into passive ELSS, which is mirroring, popular index and you are obviously enjoying the benefits of equity investing along with the tax savings. So definitely, there is space for both. That said, I think, you know, in my earlier sort of response, I was like, you know, there are some great run ELSS funds wasn't that run by some superb managers and I would definitely urge investors, if you can do some research, you know, kind of Prableen alluded to that, set that plan in motion and it shouldn't be a last minute thing necessarily, get that discipline in. There are some great funds that you can invest, but you again need to look at the fitment of that fund within your portfolio.

You know, when you because it's got to be a sort of goal driven portfolio construction approach rather than a one off. I think that's the exercise every investor should do, if they can't do it, and a passive is a beautiful way of just generating exposure to equities and getting the tax benefits.

So, alpha generation is something that you have to bear in mind is what again, I am taking from that conversation. We will come into the selection of funds at the end because I have asked you for your analysis and you have a couple of options that you think people should consider. Prableen, what are your thoughts about passive? Is the alpha generation going to be something that matters in the longer run and here we are talking about 20-25-30 years.

Prableen Bajpai: So, as Benjamin Franklin has said, that death and taxes are the only certainty and if I have to put my own money and I know that I had to put it for the next 25-30 years, and if I have the option of just going and buying the index, I'll do that, because it saves me a lot of hassle. So, there is no fund selection risk. If we look at the performance of active ELSS funds, like all other categories, there is a huge divergence between the best and the worst performance.

So, on a 10-year basis that difference is about 10% nine point eight % as on date. In terms of seven years, that difference is 12.89% and that difference is 31% for the three-year basis. Why do I want to take the risk of being stuck maybe with a fund which is not going to perform. Having said that, as Kaustubh has mentioned, there are some wonderfully actively managed funds and we do recommend, and we do invest in active funds as well.

But I feel because ELSS and tax saving can be a core to your portfolio because it's going to be there, you know, you invest year on year. So, if you have that option, you know, in a simple mode, like a passive strategy, I think it's easy, so you just pick Nifty 50 like your tax saver, I think it just makes the whole investing process simple and it's no cost and easy to understand also for a first time investor because for a lot of people, they can't go beyond that basic 12,500 investment, at least in the initial years of their career.

So I think indexing also is simpler to understand for investors. So of course, if they could do the research, then there is scope for alpha generations.

For a lot of people that have bought into the passive strategy, I think people who are investing in the Nifty 50 index have maybe a 30-40% allocation within the overall portfolio. Maybe we take a portion of that and say okay, I put it in a passive ELSS. I am anyway investing in the Nifty 50. So, I can also take a tax saving advantage that I am allowed to in the ATC. What should you bear in mind when you aren’t choosing an ELSS. Now, obviously, you are looking at the same research and methodology that you would look at Kaustubh, any other equity choice or equity mutual fund choice that you do, and you listed out a couple of options. What is your thinking and maybe that will also help people identify what they should look at? 

Kaustubh Belapurkar: So, I think you rightly said Alex, it's, it's the uniform approach that he would take for picking any fun, it'll be an ELSS or a regular diversified fund that you want to pick as a part of your portfolio. I think a few things that can are very, very important for any investor to keep in mind. I think, you know, the first thing is do not focus on past performance purely to make your choices because that can really lead you down the wrong path.

Often getting into a fund at the wrong time, coming in mismatched expectations. What we need to do is to understand the fitment of the portfolio within your overall investment portfolio the fund and b evaluate how consistently as a fund been matched. Now when we talk about consistency, your returns are a result of consistent investment processes being followed and returns will follow.

 Mind you even the best of managers will go through patches which don't look good for them because the markets are probably against their own style of investing. I will give you some classic cases. When there was in 2018-19, growth style managers did exceedingly well, and value was almost written off the street at that time.

There were several value managers who held forth to their investing process that we value managers, we will continue to do that in the same fashion and that paid rich dividends for them. You know, the last couple of years and growth has kind of slipped off because of that. Have growth managers changed track. Not really, they continued to manage it the way they did, which paid benefits for them in 2018 and 19 and they continue to do so and when growth turns around, you know, they will do well again.

So, these cycles continue to happen. What you need to do is to identify a manager who's been consistently following a particular style within that fund and obviously the returns stack up. When I mean the return stack up for growth style managers doing bad, you know, in a growth trending market, and that's a bad thing because then clearly, you know, their style is not working for them in a market that's conducive to them.

The same thing would follow for a value match, I think these are the analyses that you want to see consistency in the way the fund is being managed. Obviously, the experience of the manager or the team supporting him or her is also extremely important in terms of assessing that and then we will look to form opinions on you know, which of the consistently run strategies that are performing as per the expectations over market cycles.

You have identified a couple that you want to very quickly run through, why you have chosen those two?

Kaustubh Belapurkar: So, when you think about one of our popular or favourite strategies is actually the Mirae Tax Saver run by an extremely competent team that's Neelesh Surana. In fact, I just recently saw a tweet that he has completed 15 years at Mirae Asset, and that's phenomenal track record, that he and his team have built for them.

So when you think about his style, I mean he’s kind of a quality growth manager, but he wants to buy them at reasonable valuations and they applied this trade consistently in their portfolios for long periods of time and that really has resulted in a way I would say very good performance over market cycles for the Mirae Asset Tax Saver, which Neelesh manages along with a couple of other strategies.

So I think it's a well-diversified strategy, given that slightly valuation cap conscious approach has helped him across market cycles and he's really backed by an excellent team in terms of the primary research that put in place and like I said, the investment process has been consistently applied. So, I think that it's one great strategy, another strategy that we like, and the viewers will probably wonder, because it's a strategy that's probably going through some tough times right now.

The Axis Long Term Equity. Now this and the reason why I bring that up is because it's had a terrible last one year but let me put some things into perspective. Now Jinesh Gopani manages, and his strategy has been doing this for a fairly long time with the same consistent approach looking at quality and growth stocks, and his professed sort of style is not you know, not  minding paying some valuation premium for buying these quality growth stocks which will pay off over the long term. If I dial back time and I look at the period of 2016 and 17. He was running the same growth style, but the fund underperformed.  

Come 2018-19, the fund did exceedingly well when growth came back in favour. Now it's again going through a rough patch because values come back to the fore. But the style has not changed and that's the consistency that we are looking for. The third one, which is actually a different example, is Franklin Taxshield, which again, a great manager in Anand Radhakrishnan, he is a more value bias manager. So, I think exactly the opposite of what happened in the Axis Long Term was happening with this fund now. It struggled in the years when growth was doing well with as value has come back to the fore this manager is doing exceedingly well.

So, it's a very different style of management in that space and the reason why I am kind of talking about different styles of management, all these three being run in a different style. So, when you are an investor looking at the overall portfolio, if you have exposure to a certain style, if you invested in only growth style funds, then perhaps the Franklin Taxshield will be a great supplement to your portfolio in terms of value style, which builds an all-weather portfolio so to speak.

But if you were, you know, largely in value style managers, maybe you want to buy one of the growth style managers, so you need to complement these styles within your portfolio when you are trying to build your portfolio. 

So, diversification not just in terms of asset classes and in terms of your market capitalisation, but also in terms of styles. of investing. Prableen, any thoughts about these three funds that have been mentioned and any funds that you have looked at very closely, and you would like to recommend?

Prableen Bajpai: I will agree with Kaustubh's choice. I think all these three funds are good and I will agree especially for Axis because you know, whenever there are certain things play out in a certain market cycle, currently it's under pressure, I think in fact of all the schemes from the fund house, so I think stay put is important.

So don't keep chasing returns. I will add I think the recent ones I like Parag Parikh as well. They have very limited schemes in the Fund house. So I think they do give due attention to each one. So, I think along with these three, I like the Parag Parikh, to the fullest.